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Minimum Repayments: Back to Basics Why they're dangerous Minimum Repayment Calculator The easy three step solution A simple trick to beat the trap Minimise the interest Direct Debit Dilemma The exceptions to the rule Related Articles/Discuss

Danger! Beware Minimum Payments!

• The interest rate. This is the cost of borrowing money. Borrow £1,000 at 20% APR over a year and you'll be charged £200 interest (20% of £1,000). If you're confused by interest rates, first read the Interest Rates Beginners Guide article. In a nutshell the lower the interest rate, the less debt costs you.
• The length of borrowing. The longer you borrow for, the more interest you're charged as 20% APR means you're charged 20% of your outstanding debts EVERY year, plus interest on the interest. This is crucial with minimum repayments, as by only repaying the minimum, you're effectively borrowing for longer and therefore paying much more interest. In a nutshell the quicker you repay, the less it costs.
• The minimum repayment. Unlike mortgages and loans, with credit cards you choose what you repay; the more you pay the faster the debt disappears. The only restriction is that there's always a prescribed minimum repayment; the lowest amount you must repay each month to avoid a fine. Rather than a fixed amount, it is usually 2% or 3% of the outstanding debt, with a £5 minimum.

Our aim is diametrically opposed to that of credit card companies. We need to repay debt as quickly as possible; they want to keep us perpetually repaying our debt and earning them interest. Minimum repayments are designed to do just that.

The important thing to understand is that as the minimum is a percentage of your outstanding debt, then as your debt decreases, so does the amount you repay. This means most of your repayment usually goes just to paying that month's interest, rather than actually decreasing the amount you owe.

All of this has some startling consequences when you work out the numbers.

The Example: Mr John Shortovcash

Let's take a look at Mr. John Shortovcash's debts.

• Credit Card Interest Rate: 17.9% (pretty standard).
• Outstanding Balance: £3,000.
• Minimum Payment: The higher of 2% or £5.

Sadly John's strapped for cash and therefore can only afford the initial £60 minimum repayment, so the amount he repays reduces each month. As the table below shows, at first there's not much difference; at the start he pays £60, then a month later £59.60. Yet after a year he's only repaying £56 and soon the repayments plummet - meaning the debt lasts and lasts and lasts.

The impact of this is huge!

The fact John's paying less each month means the interest he owes isn't just adding up, it's compounding at hyperspeed. In other words, there's interest on the amount owed, then there's interest on the interest, then there's interest on the interest on the interest….. I could go on, but it'd be a very long sentence, so I'll stop there. All this interest means most of his repayments don't actually pay of any of the money he owes - it just repays the interest.

Even if John never spent on the card again, and just made the minimum repayments, it'd take him a total of 40 years and 7 months to pay off and cost £6,300 in interest.

To find out how long your card(s) will take to repay, if you just pay the minimum, use this special minimum repayment calculator below. If you don’t have the information needed, you’ll find it on your credit card statement. However if you can’t find your minimum repayment, just leave in the default settings given and it’ll be roughly correct.

There are two main reasons most people make just the minimum repayments. The first is because they simply don't know how damaging it is; if that's you, just increase the amount you repay immediately and the problem's solved.

Yet for most it's because they simply cannot afford to pay any more than the minimum. Well hopefully the rest of this site will help you through that, and I do suggest doing a decent budget (see How to Budget article), yet even if not; there are still some easy steps to help resolve the problem.

There's a remarkably easy and powerful solution to all this. The whole ‘minimum repayment' trap is based on the fact that the more debt you've repaid, the lower your repayments go. So to stop that, simply make a fixed repayment based on what you can afford; rather than allowing the repayment to decrease each month.

An example helps it make sense

Going back to John Shortovcash above, with his £3,000 debt at 17.9% interest, with minimum repayments of 2%. In the first month his minimum repayment was £60. If instead of just paying the minimums he repaid this £60 every month, the scenario would change radically.

Making minimum repayments it'd take him 41 years to pay off the debts and cost £6,300 in interest, yet repaying a fixed £60, he'd clear the in just 7 years and the interest cost would be only £2,100; a huge saving of over £4,000. Of course, if he could afford to pay even more each month, he'd be even better off.

Of course this assumes John doesn't do any more borrowing. A good thing as anyone in debt, only able to afford the minimum repayments, needs to drastically cut back on spending and avoid all new borrowing.

If the interest rate you're paying is lower, more of your repayment goes towards decreasing the actual amount you owe, rather than just servicing that interest. Minimising the interest just involves doing a balance transfer; this means you can shift debts to another card at hopefully a cheaper rate of interest.

If you've got a decent credit history then simply read the Balance Transfers article to do this. If not then you can possibly still save with a technique called the Credit Card Shuffle, just read the Existing Customer Balance Transfers article.

Always set up a Direct Debit to automatically repay credit cards as it means you'll never be fined for missing or making a late payment (see the Credit Card Charges Reclaiming article if you have been charged fees). Yet on Direct Debit forms, the minimum repayment option looms large as it's by far the most profitable for lenders.

Instead, if you can, repay a fixed amount (as discussed in step 1), though sometimes the form mightn't allow you to specify this. If that's the case, just write it in anyway, and then call up to confirm it's done; the credit card company should honour it.

Those who really can't guarantee repaying more than the minimum every month shouldn't panic. Just set up the minimum repayment by Direct Debit, but remember there's nothing stopping you making other payments by cheque or from your bank account on top. The real danger is getting into the mindset that “I'm paying my bill” just because you're repaying the minimum, always try and pay more off whenever you can.

Having driven the fear of living hell into you with the above, you may be a little surprised to read that there are times that making only the minimum repayments are good.

• When you’ve other more expensive debts
  
  A golden rule of repaying debt is always put as much cash as you can towards repaying the debts at the highest rate of interest. This means you should make only the minimum repayments on all others. That way you get rid of the most expensive debts first, and then focus on the next most expensive (see the Credit Card Shuffle article for more info).



• To stooze
  
  For the extremely financially savvy who are manipulating the credit card system to make free cash, then paying just the minimum repayments is the right move. Here if you're borrowing at 0%, and are earning money on the cash lent to you elsewhere, the idea (contrary to all other times) is to maximise your borrowing.
  
  Though let me stress, this is only for those who know exactly what they're doing (read Stoozing: Free Cash).



• To ensure you don’t get a credit card charge
  
  If you’re the type of person who may miss a payment or are late, not only will they fine you £12 a time, it is a HUGE smack to your credit rating; plus you can lose any cheap 0% or other deal you have.
  
  Therefore to ensure you never again miss a payment, set up a monthly Direct Debit even if only to pay the minimum. This may surprise after all I’ve said. Yet here, it’s a defensive strategy to avoid missing the deadlines (if you’ve had past fines read the Credit Card Charge Reclaiming article).
  
  Yet setting up this payment ISN’T the same as me saying "only pay the minimum". This is a strategic move to not get a fine. When you get your statement, there is nothing to stop you paying as much as you can on top of that via web, phone or cheque to clear your debts.

Ask a Question / Discuss

Minimum Repayments

Other Articles You May Be Interested In

Debt Problems

The Demotivator

Credit Card Newbie MoneySavers Guide

Bank Charge Reclaiming


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