Credit cards can be a highly convenient tool for facilitating daily transactions and managing personal expenses. They can also earn financial rewards, get free credit scores, secure payments from fraud, and get valuable benefits like purchase and price protection.
However, if they are poorly managed, they can quickly become a financial burden. As bills rack up, cardholders may be unable to pay little more than the minimum required monthly.
Paying the minimum required monthly balance on your credit card may seem simple and innocuous to manage your finances. This method can even offer a reprieve from financial strain. Paying the minimum means you’re current on your bills and helps maintain your credit score.
However, it is a deceptive comfort, and you should never underestimate its impact on your long-term financial health. Left unattended, it can give rise to a list of hidden dangers that affect your future creditworthiness and ability to get out of debt.
The Downsides of Paying Only The Minimum on Credit Cards
Sometimes, people have no choice but to accumulate bills and pay them off in small installments instead of in bulk. Certain life events may force you to use your credit card as an emergency fund.
In this case, minimum payments are acceptable for a short period. Understandably, you could only make the minimum on your credit card payments for a specific time frame.
However, extending this practice or making it a habit could hurt you in multiple ways. The following are the downsides of making only the minimum required monthly payments on your credit cards:
The debt snowball effect
Credit card companies make money on interest. Therefore, they are okay with your minimum payments. It means more interest accrues against your balance the longer you sustain it. You should recognize this disadvantage because it means you are losing money on interest.
Credit card companies charge anywhere from 15 to 25 percent interest and could even go higher, depending on your creditworthiness and the card’s program. By paying only the minimum, you are letting the interest on your debt compound with the balance. You set the stage for debt accumulation and the snowball effect. Unchecked, this situation could get out of control quickly.
Damage to your credit score
Multiple factors influence credit scores. The most critical factors are your credit utilization and payment history. Credit utilization is the amount or percentage of your total credit utilized at once. Credit scoring models evaluate the ratio of your credit card balance to your credit limit. Payment history refers to the timeliness of your bill payments.
High credit utilization could indicate financial distress and thus lower your credit score. Your diminished creditworthiness will affect your ability to lock in favorable interest rates on mortgages or other loans.
Obtaining emergency loans could be more difficult, leaving you vulnerable to predatory loan products that lead to more significant financial distress. A low credit score could also prevent you from borrowing money altogether, leaving no room for financial relief when needed.
Racking up penalties
When facing financial constraints, individuals often opt for the minimum payment. Therefore, the potential for late payments is also high. When there is little room for error, late payments can trigger penalties and unexpected fees. Such charges further add to your financial burden. The accumulation of late fees creates a vicious cycle that makes it harder to escape credit card debt.
Prolonged repayment period
Minimum payments extend the debt repayment period. The longer it takes to clear your outstanding balance, the higher your interest may go. In addition, the extended repayment period restricts your opportunities. It ties up your money to debt payment instead of allocating it to profitable investments. You miss out on the chance to grow your savings.
How To Break Free From the Minimum Payments Cycle
Recently, credit card balances in the United States reached a 10-year high. TransUnion’s data, released on November 9, 2023, shows that the average credit card account in the US carries a balance of $6.088. This amount is up by 15% compared to last year’s period.
Moreover, according to a report from the Federal Reserve Bank of New York, the total US card debt ballooned to $1.08 trillion in Q3 2023, a record amount. The increased debt highlights the effect of higher interest rates and inflation.
Opting for minimum credit card payments can result in various drawbacks. While it may not be possible for you to pay your credit card balance all at once, there are ways to control your finances and get out of debt faster.
Consider debt consolidation
Debt consolidation merges debts into one loan with a lower interest rate. When approved for a debt consolidation loan, you can take advantage of temporary hardship programs, lower your interest rates, and potentially reduce your fees.
How does it work? Credit card consolidation loans let you take out a new loan to pay out your existing debts. For example, you carry three credit cards, each with a balance of $2000. When you take out a consolidation loan for $6000, you pay off the total balance for all three cards. You are then left with a single loan for $6000.
It’s a straightforward process. After gathering all your debts, you combine them into one payment. The new loan allows you to pay monthly to a single location. This process simplifies your debt payment, making it easy to calculate and remember. It could also come along with benefits like a lower APR.
Pay off high-interest debts first
The debt avalanche method prioritizes the debt or card with the highest interest rate and pays it off first. This strategy reduces the overall interest paid and speeds up the debt repayment process.
To get started on the debt avalanche plan, add up all the minimums you need to pay on your debt, excluding your mortgage. Create a budget to see how much you can allocate each month to accelerate your credit card debt repayment.
After settling the highest-interest debt, you follow through with the second-highest-interest card, and so on. You continue until you pay off all your credit cards.
Use the debt snowball method
The debt snowball is an alternative to the debt avalanche. A debt snowball plan prioritizes your smallest debt regardless of interest rate. When your smallest debt is eliminated, you move on to the second smallest balance. You do this until you pay off your entire credit card debt.
If you’re the type who needs small wins to stay motivated, the debt snowball plan might work better for you. On the other hand, if you are patient, analytical, and motivated by data, you fare better with the debt avalanche method.
Negotiate with credit card companies
Lenders typically classify credit card debt as unsecured debt. With unsecured debt, credit card companies can’t go after your assets when you cannot pay your balance.
Hence, most credit card companies are open to negotiating with individual cardholders facing financial hardships. They are willing to do this to recoup as much of the debt as possible.
However, before making that phone call, you need to understand how much you owe and your options. Go through your credit card statements and list how much you owe on each card (if you own multiple credit cards). Take note of the interest rate for each.
The most common settlement options include workout agreements, lump-sum settlements, and hardship plans. You can also consider debt settlement or debt management.
Workout agreements
With workout agreements, you can request the credit card company to remove past late fees, lower your interest rate, or reduce the minimum monthly payment. Sometimes, you can request to waive the minimum monthly payment altogether.
With these options, you can start reducing your debt. You can also pay off the balance in a shorter time frame. A workout agreement could be a good choice when you have a wave of expected income insufficient to meet your current monthly obligation. Workout agreements could also be ideal when you anticipate facing longer-term financial difficulties.
Lump-sum settlements
A lump sum settlement involves negotiating to pay less than you owe. This option only works when you have access to a substantial amount of cash you can use to pay your credit card debt upfront.
In the case of lump-sum settlements, the credit card company may agree to reduce your total debt to the principal owed.
Hardship plans
When you face temporary financial challenges, you may consider a hardship plan. Moreover, if your difficulties are because of a severe illness or job loss, the credit card company may put you on a hardship plan, typically a structured payment plan. If you fit into this situation, consider asking your credit card company if they can offer you a plan based on their hardship program.
Debt settlement
Some for-profit companies offer to negotiate with credit card companies on your behalf. These mediators—debt settlement companies—try to get the credit card companies to agree to a “settlement.” Such settlements are usually lump-sum payments that are less than your entire debt.
For this service, the consumer pays the debt settlement company a monthly payment placed in an account. When the debt settlement company arrives at a settlement amount with the creditor, the payments are withdrawn and used to pay the creditor. These debt negotiators typically take a service fee along with the settlement.
However, using debt settlement companies is not ideal, as they are associated with certain fees and can harm your credit score. This option should be among your last resort before filing for Chapter 7 bankruptcy.
Debt management
When saddled with credit card debt, you can turn to organizations to help you navigate your financial plan. The National Foundation for Credit Counseling and other nonprofits offer credit counseling and debt management programs. They allow you to devise a debt management plan.
Under this system, you deposit money with the credit counseling agency monthly. The agency or nonprofit then uses your deposits to pay your creditors on an agreed schedule. When enrolling in such programs, expect qualification requirements and service fees. Typically, they require that you be able to pay off your credit card debt in a maximum of 60 months.
Debt management programs are generally better than debt settlement. If you qualify, they are the more favorable option. Debt management programs cost less and don’t impact your credit scores as negatively as debt settlement.
Cut your expenses
Even the best-intended debt payment plans are useless without adjusting your lifestyle and expenses. The first thing you need to do is get on a budget. Create a budget you can live with.
To eliminate credit card debt, you must account for every dollar you have. Any extra money you save goes straight to your debt payments.
After listing all your budget items, consider which expenses you can cut. It will take a lot of work, but think of it as a temporary measure to achieve your financial goals. You can cut expenses like dining out, entertainment, subscriptions and memberships that are not regularly utilized, and random or occasional food expenses. Every budget cut helps you get out of credit card debt faster.
This measure doesn’t mean you completely deprive yourself of personal rewards—after all, motivation is essential to your commitment. Just think that those rewards must be budget-friendly for this temporary phase. While you’re cost-cutting, it helps to be creative.
Reduce your bills
Alongside expense reduction, lowering your monthly bills helps you put more money into debt repayment. For example, meal planning and monitoring your electricity use can cut your monthly expenditure and help you free up more money to pay your credit card balance.
Earn extra income
Supplementing your primary source of income can provide the necessary boost to expedite your plan for financial freedom. Cost-cutting can only get you so far. Ultimately, you must make more money to pay off your debts faster. In addition, earning additional income provides breathing space to think long-term about your finances.
Come up with ideas for a side hustle. Chances are you have some skills you can utilize towards additional work. Online reselling, becoming a ridesharing driver, taking on freelance gigs, and giving lessons are all viable ideas. Consider asking for extra work hours at your current job.
Adding more income streams will take more time and energy, but the benefits could add up. You could pay off your credit card debt considerably faster.
Get Out of Financial Quicksand: Pay More Than The Minimum on Your Credit Cards
Being deep in credit card debt is nothing short of getting stuck in financial quicksand. Making only the minimum payments on your credit card ensures you are continually mired in debt. Minimum payments make it much harder to free yourself of debt over time by impacting your interest rate and credit score.
While staying within the minimum payment might seem convenient, it has deceptive and detrimental effects on your financial health. Extended repayment methods, interest accumulation, and the potential for additional fees underscore the urgency of breaking free from the debt cycle.
The key is to be proactive and to act on paying off your credit card debt faster. Consider solutions such as the avalanche or snowball methods for paying debt, debt consolidation, generating additional income, negotiation with credit card companies, cost-cutting, and getting advice from financial experts on managing debt.
Your strategy will depend on your preferences and financial situation. A slight change goes a long way regarding credit card debt repayment, and each proactive step gets you closer to debt-free living.
Featured Image Credit: Andrea Piacquadio; Pexels
