One of the ways that credit cards and financing companies trick us into giving away more money than we intend is by using a tactic called “The Minimum Payment”. Simply put, the minimum payment is the lowest amount of money we can pay to keep our names in good standing with those who loaned us the money in the first place. The amount of money you pay towards a minimum payment will range based on the interest and the amount of money borrowed or financed with most payments starting as low as $15. Not surprisingly these minimum payments could be causing you to be keeping yourself in debt forever.
When we buy something on credit, we tend to spend more than we would have if we were spending cash. This is because there’s no emotional attachment to the money when you swipe a credit card. When the bill arrives, we are then given three options. You can pay the bill in full, pay an amount higher than the minimum amount due, or simply pay the minimum. If you didn’t have an emotional attachment to the money spent when you swiped your card you definitely will when it comes time to pay the bill. This is why most people choose only to pay the minimum balance due. They don’t want to part with more of their money than they have to, and the credit card companies are completely okay with that! They want to you pay the minimum balance because when you do it allows interest to accrue on what is remaining. So basically you’re making them money off the fact that you don’t want to give up your money. This is a big win for the credit card companies and ultimately a loss for you.
Let me break it down further, let’s say your out with your friends shopping, and you come across this amazing sale at a department store. You have a good bit of cash you could use, but you don’t have enough to purchase everything you want, so you pull out your credit card and swipe it. No harm no foul. 30 days later you receive your statement in the mail telling you that you owe $1500 at a 12.99% variable interest rate. You can either pay that off make the minimum payment of $30.00 If you choose to make the minimum payment come the next bill you will now owe $1485. But, wait you paid $30, so shouldn’t you owe $1470 instead of $1485? Yes, you should, but you forgot about interest. Half of your minimum payment went to cover the interest that accrued on your account. Sucks don’t it. Of course, as you pay down the balance the amount going towards interest will get smaller but seriously who has time for that?
Take a look at a real life scenario above, my student loan payment. The minimum payment is only $48.07 a month, and because we haven’t gotten to it on our debt snowball, we only make the minimum payment. You can read about setting up a Debt Snowball here. From my payment, $22.39 is paid towards overall balance, and $25.69 goes towards the interest! If I keep this up for a year, I will have paid only an estimated $270 towards the actual principle amount. When you owe a balance of over $4000 paying so little means you’re going to be paying on something like this for a really long time.
If you want to know what something really cost you check out this Minimum Payment Calculator for Credit cards. By paying cash, paying the balance in full, or paying more the minimum amount due you’re putting yourself in a position where the banks can’t take advantage of you thus allowing you win financially.