Does Making Minimum Payments Hurt Your Credit?

If you think the bank creates the amount due on your credit card bill every month in order to be paid back quickly, you couldn’t be more wrong. In fact, here’s an interesting warning on my Capital One credit card statement in bold letters:

“MINIMUM PAYMENT WARNING:

If you make only the minimum payment each period,

you will pay more in interest and it will take you longer to pay off your balance”

You paying only the minimum makes the bank more money. And, that’s not to mention how just paying the minimum can hurt your credit.

Understanding the minimum payment

That minimum payment shown on your monthly credit card bill is actually the lowest possible monthly payment the bank or lender will accept. This also applies to car loans, mortgage loans and student loans. If you do the math, you will find most minimum due amounts equal only 3-5% of the total amount you owe.

Currently, banking regulations require that minimum payments include all monthly fees and interest and paying off a portion of the principal amount. There was a time when minimum payments did not cover all the fees and interest and minimum payments covered none of the principal balance. These charges would add to your balance every month causing the amount you owe to continually rise, called “negative amortization,” even if you made the minimum payment and did not charge anything else. But, the Federal Deposit Insurance Corporation (FDIC) passed regulations in 2003 requiring banks to set minimum payment amounts to cover a portion of the principal and all the monthly fees and interest so consumers don’t slide backwards into debt.

Even so, minimum payments still represent a very small percentage of the balance owed and provide very little pay-back power if you are trying to get out of debt and improve your credit score. And, if you charge more, that balance will continue growing.

Paying only the minimum payment lengthens the time you are in debt and increases the amount you pay back

Because you are paying so little toward the principal balance every month you are extending the amount of time you are in debt which increases the total amount you will pay in interest. Conversely, the more you can pay towards the principal (after paying interest and fees every month) the quicker your balances will be paid off, resulting in less interest paid overall.

Gather up your bills and enter each balance, interest rate and minimum payment percent (use a percentage calculator to figure this amount first) into a credit card minimum payment calculator to show you how long you will be in debt and how much you will ultimately pay back if you continue to just make the minimum payment due. Play around with different debt scenarios for your personal debts by increasing the percentage of minimum payment to see how it affects the total payback time as well as how it reduces the total amount of interest. Of course, this assumes that you are not charging on the cards at all.

Paying just the minimum reduces your credit score

More specifically, paying just the minimum hurts the “amounts owed” portion of your score which accounts for 30% of your FICO credit score. That means you are using a large portion of the credit extended to you. Lenders like to see low credit utilization, below 30% and some experts say even 10% is best (if you consider maxed out cards are at 100%.)

And, if your cards are maxed out, paying the minimum payment due may not be enough to stop you from going over the limit with interest and fees and incurring an “over-limit fee” which puts you again in a negative amortization position, adding to your balance owed instead of decreasing it.

Always pay more than the minimum payment due

Any time you pay more than the minimum payment, you will reduce balances, the total amount of payments due and the length of time you are in debt. If you can’t pay more, it’s important to make that minimum payment due on time to keep the “payment history” portion of your FICO credit score strong. But, the prevailing advice is never to carry a balance and to always pay off balances by the statement due date to avoid minimum payments and interest charges altogether. That’s how you show lenders responsible credit behavior and raise your credit score.