Unlike a mortgage or a loan, you can choose what you want to repay. The minimum payment on a credit card is exactly what you’d expect. It’s the minimum you must pay against your card balance to your provider every month in order to avoid additional fees. Your monthly minimum payment is worked out based on your credit card’s interest rate (APR) and the amount that has been borrowed. The longer you borrow for, the more interest you’re charged.
How does a minimum payment work
The minimum payment is normally set at the greater of a percentage of your balance or a cash amount such as 1% of the balance or £5. Added to this will be any interest due for the month, fees incurred from a default in payment and part on any annual card fees.
This means as you pay off more of your balance, your minimum payment should gradually reduce. However, this method will mean it will take longer to pay the total balance off, as you pay less and less each month. As a result, you will be paying more interest on your balance.
Should I make the minimum repayment?
If you’re using a credit card, it’s generally a good idea to pay off as much as you can each month. This way you’ll be able to reduce your balance as quickly as possible, without having to pay too much interest on top of the credit balance.
For example, if your credit card debt stands at £5,000 with a 16% APR and your minimum repayment is either 3% of your balance or £10:
- Paying the minimum means it would take over 16 years to pay off your debt, and you’ll end up paying £3,339, in interest
- Paying a fixed sum of £300 a month means you’d clear your balance in one year and seven months, paying only £636 in interest
How expensive are credit cards
To understand how expensive credit card are in relative terms, it’s important to know the annual percentage rate (APR). This is effectively the cost of borrowing, annually.
When comparing loans and mortgages, you might find that the APR can be somewhere around 3% to 7%. This is considerably lower than most credit cards, which can have an APR of somewhere in the region of around 15% to 45%. However, you are likely to be borrowing much less on a credit card at any one time than you are if you have taken out a loan or mortgage. Credit cards will be the most expensive when comparing to other products as you will be borrowing at a much higher rate.
APR is the annual cost of interest, only if you made the minimum payments due on the card each month, with the cost being paid monthly.
The monthly cost of interest is usually the total APR divided by 12 (months). This interest is also not usually compounded. So, if you don’t repay the balance in full each month, the interest will accumulate more interest.
Direct debit instead of a minimum payment
Sticking to the credit card’s minimum payment option can be one of the most expensive ways to manage your credit card. One of the simplest ways of reducing the amount of debt on your credit card is to set up a direct debit with your bank each month to pay off a fixed amount each month. Instead of making the minimum payments, you have set up an affordable amount to realistically clear down the debt as quickly as possible.
When first setting up your credit card, it’s worth setting up a direct debit to clear the balance in full each month as to avoid any late payments and falling into a debt trap.
Cut your credit card interest
Another way to reduce debt on a credit card is to contact your credit card provider and ask if they can reduce your APR on your card. It’s not always in the best interest of your provider to cut the rate but there are other factors that can influence this to your advantage.
The market is a heavily competitive industry to win and retain customers. Therefore, plenty of deals are available to new customers offering low interest rates, cashback, airmiles, travel benefits, 0% on purchases and plenty more. Credit card companies would rather you owed debt to them than their competitors.
If they can’t offer an improved rate, then consider moving to a new provider and getting a balance transfer credit card.
