A credit card balance that remains unpaid is a cause for concern. Settling only the minimum payment helps to keep your account current. However, it does not ensure financial security. How much should you pay to reduce your credit card balance? Read on to find out.
Charging items to a credit card is easy. Deciding on how much to pay when your bill payment becomes due is difficult. This is because the amount you can pay is dependent on other factors such as how much you earn and what other financial commitments you have. A mortgage or insurance payment will rank higher on your list of priorities than your credit card payment. Here are some tips to help you decide how much to pay on your credit card.
Understand How Your Payment is Calculated
Your credit card billing statement will show the balance outstanding, your approved credit limit, the annual percentage rate (APR), and the minimum payment due from you on the bill payment date. Is your outstanding balance high compared to your approved limit? Have late fees and other charges increased your outstanding balance beyond your approved limit making you liable for over-the limit fees? What is the APR that applies to your payments? What method does your card company use to calculate outstanding balance for the purpose of calculating interest? How is your minimum payment calculated? Is your interest rate fixed, variable or stepped up? Your billing statement as well as the cardholder’s agreement will provide the answers to these questions.
Is Paying the Minimum Payment Sufficient?
Most credit card companies charge a minimum payment based on two to four percent of the outstanding balance. For example, if your outstanding credit balance is $500 and your minimum payment rate is two percent, then the least amount due on the bill payment date is $10 (=500x2%). If your applicable APR is 15 percent, this means your monthly interest amounts to 500 x 15%/12= $6.25. Of the minimum payment of $10 you make, only $10-6.25 =$3.75 is applied to reduce the outstanding balance of $500.
Assuming you do not charge anything more to your credit card, your next minimum payment will be computed on a balance of $496.25 (=500-3.75). This time around, your minimum payment works out to $9.92. Of this, $6.20 is applied against interest, and the balance $3.72 goes to reduce your principal. If you make only the minimum payment, a higher percentage (in this case 62.5 percent of each payment is applied against interest while the balance helps to reduce your outstanding principal. At this rate, it will take a long time to pay off your credit card balance.
Why Paying More Than the Minimum Payment is Better
While paying the minimum payment is accepted as being current on your account, the better option is to pay more than this each month. There are many websites that provide online calculators, including this one at Bankrate.com that will help you see the cost of paying only the minimum amount. Other than the obvious saving in interest, paying down your credit card debt helps you to settle your balance faster. This will also improve your credit score and would be beneficial if you intend to apply for a mortgage or other loan.
Why Paying Your Full Balance is The Best Option
A credit card can become a burden if you max it out and let late payment charges and other fees accumulate. On the other hand, the best way to take advantage of a credit card and improve your credit score is to settle the full balance that is due on the bill payment date. You have the benefit of enjoying an interest-free credit period of four to six weeks to settle your dues. When your next billing statement arrives, the balance outstanding represents only the purchases you made since your last billing cycle.
Settling the full balance on your credit card requires discipline. It means using your card wisely so that your expenses are below your earnings. Proper budgeting, prior planning for big ticket items, and avoiding impulsive shopping can help to keep you on course.
How much of your credit card balance should you pay? Paying the full balance is the best. Paying more than the minimum payment and as much as you can afford is the next best option.
1. Ladka, Susan. "“Minimum payment on credit card", http://www.bankrate.com/finance/credit-cards/minimum-payment-on-credit-card.aspx
2. Arnold, Kristin. "Calculating your minimum payment",http://www.bankrate.com/brm/news/debt/20050503b1.asp
3. FTC Consumer Alert. "Using A Credit Card: Your Rights and Responsibilities", http://www.ftc.gov/bcp/edu/pubs/consumer/alerts/alt137.shtm
4. Bankrate.com credit card calculator- how much will the minimum credit card paying cost me?, http://www.bankrate.com/calculators/managing-debt/minimum-payment-calculator.aspx