The Financial Wilderness is a fan of credit cards under only very specific circumstances – namely that they’re paid off in full each month or part of a well planned expense you know you can pay back. When speaking with friends who’ve got into credit card debt, one of the biggest common themes was they got into the situation via only making the minimum payments required, so I thought I’d cover that today.
Unfortunately, the credit card minimum payment is a little bit of a financial trap. It looks so appealing because it looks such a small and easy number when you’re dealing with many of life’s financial pressures, but it’s very easy to create an ever growing debt spiral of o’pain (official financial term), so this entry seeks to explain why that is and why you should avoid credit card debt by making more than the minimum payments.
This post is about prevention. If you’re already in credit card debt and need a cure don’t panic: the next post will be about strategies to turn credit card debt around.
Why is Credit Card Debt a Problem?
The big thing that’s changed and can make credit card debt tricky to manage is having visibility over spending. I love contactless because it makes things so quick and easy, but also just a little too quick and easy – you can rack up that total fast without feeling like you’re spending anything……
So when that statement comes in many people see the option for a minimum payment which is a relatively small amount each month. It’s so tempting, but we really do advise you not to if you have any option at all.
Why you should avoid the Minimum Payment on your credit card
Let’s head back to what we’re trying to achieve financially with the Golden Rule this site is built on:
How do Necessities (We ensure) + Luxuries (We challenge) + Wastage (We eliminate) balance against Core Income (Your job) + Investment income (We maximise) + Other Incomes (We seek opportunity)
When you pay the minimum payment the entire rest of the balance is subject to interest – I.E because you are essentially being loaned money, the card provider will charge you for that. This is essentially wastage over time.
Elsewhere on the blog we talk about how compound interest or the long term effect of money over time does wonders for investments when you’re in credit – but with credit card debt it’s more like black magic, slowly sapping at your soul.
Let’s demonstrate: Assuming £1,000 spent a month on a card charging 2.5% interest a month and requiring a minimum of 5% of the balance to be paid off we end up with the following:
| Month | Debt at month start (pay off in full) | Debt at month start (pay minimum only) | Required minimum payment |
| 1 | £1,000 | £1,000 | £50 |
| 2 | £1,000 | £1973.75 | £98.69 |
| 3 | £1,000 | £2921.94 | £146.06 |
| 4 | £1,000 | £3845.24 | £192.26 |
| 5 | £1,000 | £4744.30 | £237.21 |
| 6 | £1,000 | £5619.76 | £280.91 |
Yikes! Not only is that minimum payment balooning worryingly fast, your overall debt is getting pretty big, which can lead to additional problems with obtaining further finance.
How am I losing out by paying the minimum on my credit card?
Now let’s show the wastage here in the form of those interest payments.
Let’s say we received a big cash windfall and pay the card off in full after month 6 and compare results.
If we’d simply paid off the card immediately each month we’ve simply paid £6,000.
However, having paid the minimum each month before paying off the card in month 6, instead we’ve paid £5619.76+£237.91+£192.26+£146.06+£98.69+£50 = £6,345 (£6,000 pure spend and £345 of interest cost)
You know what? I reckon that’s £345 lost we could be doing a lot more with. Let’s get there.
How can I manage credit card debt?
If you’re not paying off in full and are worried about credit card debt check out the next article on practical strategy to get those credit cards under control.
Any questions?
It’s very easy to find yourself in a tricky situation accidently with credit card debt, so if you have any questions, please just let us know in the comments below!
And that’s it!
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