Why only paying the minimum due on credit card may not be a wise move?

Credit cards have become a popular financial tool for millions of consumers. But defaults are on the rise too. In the first half of 2024, credit card defaults climbed to 1.8 per cent, up from 1.7 per cent at the end of 2023. To escape paying late fees, some people also pay the minimum amount due on the card.

  But what seems like a convenient option may quickly transform into a financial nightmare for unsuspecting cardholders.

  What is the minimum amount due?

 

The minimum amount due on credit cards represents a small portion of the total outstanding bill, typically ranging between 5 to 10 per cent. Paying this minimum amount allows cardholders to avoid late payment charges and maintain the active status of their credit card.

 

However, opting to pay only the minimum amount can lead to an increased debt burden. Banks impose interest on the remaining unpaid balance, which can exceed 40 per cent per annum for certain credit cards. Furthermore, any new transactions made using the card will also incur these interest charges until the full outstanding balance is cleared.

 

“Paying the minimum amount due on a credit card sounds easy, but it turns into a debt trap from which there is little chance of rescue. It might create a vicious cycle of debt that becomes hard to pay off. Thus, avoid falling into this trap, and try to pay a higher amount than the minimum due or try to clear the outstanding amount,” said Rajesh Katoch, CEO, of EZ Capital.

 

How is the minimum amount due calculated?

 

Credit card issuers determine the minimum payment based on several factors, including your total balance, interest rate, and a small percentage of the principal. Here is an example to illustrate how to calculate the minimum payment on a credit card.

 

Suppose your credit card balance is Rs 50,000, the annual interest rate is 18 per cent, and the minimum payment requirement is 5 per cent. The minimum amount due would be calculated as follows:

 

(Outstanding balance × Minimum payment percentage) + Interest

 

= (Rs 50,000 × 5 per cent) + (Rs 50,000 × 1.5 per cent) [18 per cent ÷ 12 months]

 

= Rs 2,500 + Rs 750

 

= Rs 3,250

 

“Paying only the minimum on your credit card is like running on a treadmill. You are putting in effort but not getting anywhere. It is a cycle that benefits the lender, not you. You can break free from this trap by paying more than the minimum, better yet, the full amount. Reduce your debt faster, save on interest, and reclaim control of your finances,” said Prashant Kumar CEO and Founder at Kredit.pe.

 

Experts suggest strategies to manage credit card

 

Full payment: Always aim to pay the entire outstanding amount. This helps avoid interest and maintains a healthy credit score.

 

Partial payment: If full payment is impossible, try to pay more than the minimum. Even an additional Rs 1,000-2,000 can significantly reduce interest accumulation.

 

Debt consolidation: Consider balance transfer options or personal loans with lower interest rates to manage credit card debt.

 

Financial planning: Create a monthly budget that prioritises credit card payments and builds an emergency fund.