Avoiding the Minimum Payment Trap

Many of us have credit cards and love the flexibility and freedom they give us to spread the cost of larger purchases, and to make life a bit easier in more expensive periods. However, they’re not without their pitfalls.

One particular thing to watch out for is ‘minimum payments’. Falling into the trap of repaying only the minimum each month could cost you a fortune in interest and leave you in debt for longer — potentially even decades.

Here’s the rundown on how minimum payments work, and what you need to know about avoiding the minimum repayment trap:

What does minimum repayment mean?

Unlike a loan, where you are usually expected to repay the same amount every month, credit cards tend to give you greater freedom to decide how much (or little) to pay off the balance from month to month.

But all cards have a ‘minimum payment’. This is the minimum amount you need to pay each month in order to avoid additional fees, charges or interest, or harm to your credit file. This ‘minimum payment’ is calculated based on your card balance, so it will go up or down depending on the total amount you owe.

Why is it a trap?

Given the freedom to choose, it’s tempting to just pay the minimum payment each month. After all, why pay more than you have to? This is especially true when money is tight — most of us have things we’d much rather spend money on than our credit card bill.

The problem with the minimum payment is that, while it keeps the credit card company off your case by ensuring the interest is paid, it doesn’t take much of a bite out of the balance of the card itself (the amount you actually owe). You can literally stop spending on the card, pay the minimum payment each month, and still never be any closer to paying off your debt.

It’s a trap that’s easy to get into, but can be much harder to get out of.

A simple example:

If you have built up a credit card debt of £2,000, and the interest is 20% APR, you’ll pay £223.23 in interest over the year, or £18.60 per month. So you’ll need to pay at least £18.60 per month just to keep up with the interest.

Say the minimum payment required by the credit card company is £20 per month. Easy, right? But while it’s tempting, remember that £18.60 of that is covering the interest. Only £1.40 that is left over goes towards paying off the actual £2,000 debt.

So by making the minimum payment, the credit card company will be making £18.60 off you every month. But your debt is only going down by £1.40. You can keep doing that month after month after month, but you’ll never be closer to paying off what you owe — the majority of your repayment is covering the interest.

Lots of people wonder why, if they’ve stopped using their credit card, and they make a payment every month, the balance they still owe isn’t going down. This is why.

How to avoid being stuck in the minimum repayment trap

The good news is that with some planning, you can get out of the ‘minimum payment trap’ and get yourself on the road to paying it all off. Even if it takes several years, there’s light at the end of the tunnel. It’s certainly better than throwing money away each month on interest, while having the debt hanging over you indefinitely. Here are some tips:

• If you can afford to, you should aim to pay off as much of your credit card as you can each month. The quicker you pay off your balance, the less money you’ll end up spending on interest.
• If your situation has changed, or you genuinely can’t afford to pay above the minimum, contact your card provider. Under rules introduced in the past years, they are obliged to help you find a solution — this could involve pausing interest for a while, converting the card into a loan, or offering a repayment holiday.
• If your credit record is strong, you may be able to take out a consolidation loan to help you completely clear the credit card debt. Consolidating the debt means that although the monthly payments are likely to be higher, the interest charged is likely be less. So more of the repayment each month goes towards paying down the debt itself.