One of the most enticing features of a credit card is being able to make the purchases you want and only have to pay for a fraction of them when your credit card statement arrives in the mail. The amount of this minimum payment is calculated by your credit card company and reflects a percentage of your total balance.
Making your minimum payment keeps you looking good on paper: You avoid late fees and being reported to the credit bureaus for non-payments. You don’t have to worry about non-payments lowering your credit score. But minimum payments are one of the ways that credit card companies make money off of you. Compound interest and finance charges cause you to pay more than the actual purchase price for a long time.
Here’s an example of what paying only the minimum balance can cost you. Say your credit card company sets your minimum payment at 4 percent of your total balance, and your balance is $1,000. If you pay just your minimum payment, at 15 percent annual interest, it would take you six years and eight months to reach a zero balance. You’d also have had to pay almost $400 in finance charges. And that is assuming that you don’t use your credit card for any additional purchases.
One of the best ways to avoid falling into the minimum payment trap is to set a budget for yourself. Examine your income and spending habits and determine how much you can spend on your credit card and still be able to pay it off each month. Or, if you have already started the habit of only paying the minimum, re-work your budget so that you can gradually increase your payments. That way, you can get out of debt faster and free up cash for other things you need.