What Are Minimum Payments?
Minimum payments refer to the smallest amount you can pay on a debt and still be considered current with your payments. The term minimum payment is usually used in the context of credit cards. Even though you might think you're doing just fine paying the minimum, if that's all you pay, it can take you several years (and potentially thousands of dollars in interest) to pay off a debt.
Calculating Minimum Payments
Different credit card companies calculate minimum payments with different formulas. For example, one credit card company might set the minimum payment at the interest charged plus 1 percent of your new balance or $35, whichever is large, while another company might figure your minimum payment as the larger of $25 or 1 percent of the new balance, plus interest, plus late fees. Check the terms of your credit card agreement to determine how your minimum payment is set.
Benefit of Making the Minimum Payment
Making the minimum payment keeps you classified as being current on your loan and stabilizes your credit score, in some cases. Even if you only make the minimum payment, your credit report will show that you paid on time each month. However, your credit score could suffer because unpaid balances show up on your credit report as outstanding debt. Thirty percent of your credit score takes debt into account, including debt in relation to your credit limit, so you can still hurt your score if you pay just the minimum.
Interest Charged on Your Balance
Making the minimum payment on a loan helps you avoid being slapped with late payment fees and missed payment penalties. However, whatever amount remains on your balance gets charged interest, so making the minimum payment isn't cheap. For example, say you have a $2,000 loan balance and you make a minimum payment of $100. Though your credit report will show you as paying on time, the credit card company will charge you interest on the remaining $1,900 of your balance until you pay it off completely.
No Need to Carry a Balance
A common misconception is that you need to carry a balance on your credit card to improve your credit score. Fortunately, this simply isn't true. Therefore, if you can afford to pay off your bill in full each month, there's no reason not to do so. That way, you're not paying extra interest and receiving nothing in return.