Explained:The hidden costs of paying only the minimum on your credit card

Since only a small portion of your payment goes towards the principal balance, it takes much longer to pay off the debt completely.

While paying just the minimum amount due on your credit card might seem like a temporary solution to manage your finances, it can lead to a cycle of debt with significant repercussions as credit card companies charge high interest rates on outstanding balances. 

When you pay only the minimum amount, a significant portion of your payment goes towards interest, leaving a very small amount to reduce the actual borrowed amount. This creates a snowball effect, where your debt keeps growing even if you're making regular payments.

Debt spiral:

"When you pay only the minimum amount due, you can avoid late payment charges, but the remaining unpaid balance starts attracting finance charges, which can go up to 42% p.a. Moreover, when there is unpaid balance in your account, all new purchases become ineligible for the interest-free period, which means they will incur finance charges from the first day. This can quickly start a debt spiral and turn a small overdue into a huge debt, especially if you continue paying only the minimum amount due for several consecutive months," said Rohit Chhibbar, Head of Credit Cards Business, Paisabazaar.

 

Example: Imagine your credit card balance is Rs 10,000 with a 18% annual interest rate. The minimum payment might be Rs. 500. If you pay only the minimum, after a year, you'll still owe Rs. 8,143 (excluding any additional purchases). The interest alone will be Rs 1,857, which eats away at your ability to pay down the principal amount.

" By paying only the minimum, you prolong the time it takes to pay off your debt. This can stretch out for years, trapping you in a cycle of debt repayment. Credit cards typically have high-interest rates. When you pay only the minimum, the remaining balance carries over to the next month, accruing interest. This means you end up paying more interest that significantly increasing the overall amount you owe to the lender. Also, when you only pay the minimum, your credit utilisation (CUR) remains high, which can lower your credit score. A lower credit score can affect your ability to get loans or credit cards in the future," said Adhil Shetty, CEO of Bankbazaar.

Let's take another example: You have a credit card balance of Rs 50,000 with an annual interest rate of 24 per cent. If you pay only the minimum amount due, which is usually around 5% of the outstanding balance (Rs 2,500 in this case), it will take you longer to pay off the debt. During this time, you could end up paying thousands of rupees in interest alone, far exceeding the initial Rs 50,000 debt. 

That is why it is recommended to clear off your entire credit card dues and avoid carry over the debt into subsequent months.

 Credit utilization ratio, which is the percentage of your credit limit you're using, is a major factor influencing your credit score. Consistently carrying a high balance on your credit card reflects poorly on your creditworthiness, potentially lowering your credit score. A low credit score can make it difficult to qualify for future loans or mortgages, or result in higher interest rates on those loans.

When your credit utilization ratio is high due to minimum payments only, lenders might view you as a risky borrower. This can make it difficult to qualify for future credit cards, loans, or even lines of credit, potentially hindering your ability to manage unexpected expenses.

Alternatives to paying only the minimum:

1. Create a budget that categorizes your income and expenses. Track your credit card spending to avoid overspending and stay within your limits.
2. If possible, try to increase your minimum payment amount beyond the bare minimum. This will help you pay down the debt faster and reduce the overall interest cost.
3. Look for credit cards with a lower introductory interest rate on balance transfers. This can allow you to consolidate your existing debt and pay it down quicker with lower interest charges.

 By avoiding the trap of minimum payments and taking control of your credit card usage, you can enjoy the benefits of credit cards without facing the harmful repercussions of long-term debt.