Are you repaying only the minimum payment on your credit cards each month?
It might seem like your credit card provider is doing you a favour by charging a low minimum monthly repayment on your credit card. After all, the less you have to pay back, the more cash that stays in your pocket each month. However, according to research from the BBC, only 59% of consumers manage to repay their credit card balance in full each month. Meanwhile, millions of consumers are repaying only the minimum payment amount each month, and on average, will take up to 30 years to clear their debts.
Managing your relationship with credit cards
Ideally, you should aim to repay the balance of your credit card in full each month. Credit-savvy consumers can earn rewards or cashback for doing nothing more than using credit card as an everyday addition to or alternative to cash, and repaying the balance in full each month. If you are using your credit card for large purchases and wish to spread repayments over a number of months, you should use a credit card designed for this purpose, such as a low interest credit card or a credit card that offers a lengthy interest-free period on new purchases as an introductory offer. When used properly, these cards can be an excellent way to regulate cash-flow after making expensive purchases, while minimising interest charges. However, a large number of credit card users manage their credit card finances in the least consumer-friendly option, by repaying only the minimum monthly repayment amount on their credit card balance each month. This is a particularly unwise financial decision, as paying only the minimum repayment amount each month can have far-reaching negative effects on your finances in the long term.
Know the facts
Paying back only the minimum monthly payment each month makes your credit card provider very happy; after all, the longer you remain in debt, the more interest they are able to charge you, and the more profit they make from you. The average minimum monthly repayment on UK credit cards has fallen over the past few years, with many providers now requiring only 2-3% of the balance each month from their customers. Around one in ten credit card users in the UK makes the ill-informed decision to do just this, and repay only the minimum amount each month. Repaying a credit card debt by paying only the minimum monthly repayment amount each month will take a long time – and the longer your debts remain on a credit card, the more interest they will accrue.
What does this mean for your finances?
This is bad news for your long-term finances. Although you may not feel worse off in the short-term, with only a small amount of your income being allocated to credit card debt repayment, in the long run you are going to pay largely inflated prices for your purchases.
The average minimum monthly repayment on UK credit cards is very low – usually around 2-3% of the balance. On a card that charges interest at a rate of, say 16%, the following shows an example of the calculations based on a balance of £3000:
Balance this month - £3000
Annual interest rate – 16%
Monthly interest rate – 1.23%
Interest charge for this month - £36.90
Minimum monthly repayment charge for this month at 2% - £60
The debt has been reduced this month by £23.10
As you can see here, the monthly repayments are hardly making a dent in the principal debt, with the majority of the repayments covering only the interest charges. It will take years to clear the debt this way – and cost hundreds of pounds in interest charges that could be avoided by repaying debts as quickly as possible.
Don’t let your credit cards control your finances
It is fair to say that credit card providers know that a certain percentage of consumers do not have a healthy relationship with credit cards. They know that if offered the option, many people will repay the minimum amount possible each month, remaining in debt for a long time and paying a lot of interest (= profit) in the process. Even if you find it difficult - or impossible - to clear the monthly balance each month, you should aim to repay at least 5-10% more than the minimum monthly repayment amount each month – this will take years off the time it takes to repay and greatly reduce the interest charged. You should also look into alternative debt management products, such as utilising an interest-free balance transfer credit card that offers an interest-free period as an introductory offer, or consider alternate options such as secured and unsecured loans. If you do feel that your debts have spiralled out of control, see our article Personal Debt Dos and Don’ts for more information on this topic and some simple steps you can take to begin reducing your debts.
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