Why You Should Never (Ever) Only Pay the Minimum Payment

August 10 2020 | Category: Money advice

Credit cards. Love them or hate them, most people in the UK have one. The amount you have racked up in debt on your credit cards may vary, but each month you will be given a minimum amount to pay off, along with your new or current balance. Typically, the minimum payment will be around 3% of the outstanding balance of the card – but a lot of banks have a minimum of £25 each month until the balance is 0.

For many people, they aim to pay the minimum amount off each month, thinking that means they are cutting down the debt, albeit slowly, and they can use their remaining money for other things. But that isn’t necessarily true, since interest payments will usually keep this building up – meaning your minimum payment isn’t actually paying anything off your balance! If that wasn’t enough, here are 3 other reasons you should pay more than the minimum amount on your credit card bill.

You Save Money

This might sound a bit backwards but bear with us here. According to studies of the market, keeping a balance on a credit card suggests that you might be spending more money than your budget would allow for. And since keeping a balance on a credit card is expensive, that’s not really surprising, and many people get stuck in a cycle of debt even if they are paying off the minimum amount. While paying your minimum balance will keep your account in good standing and make sure no debt collectors come knocking at your door, it will end up costing you much more each month than it needs to. Why? Because the balance at the end of each month will accrue interest, which can sometimes wipe out any balance you had paid off and makes it much harder to actually pay off your balance. If you pay off more than the minimum, you can make a real dent in the debt, your interest will be lower, and you will have even more money to spend at the end of the month.

You Pay off Your Balance Faster

When you only make the minimum payment on a credit card, it can take a long time for you to pay off your balance completely, which means you end up paying more in the long run. For example. Let’s say you have a £5,000 balance on a credit card with an 18.9% interest rate. Your minimum monthly credit card payment would be £200. That might not seem like a lot, but it adds a lot to your total balance and will take you much longer to pay the debt off.

That regular £200 minimum monthly payment would take almost 3 years to pay the card off completely (33 months to be exact), and when you tally it up you’d end up paying an extra £1,410.23 in interest on that £5,000 balance that you just didn’t need to pay. But, if you pay £460.54 each month towards that same credit card, you would end up paying only £529.69 in interest, and the whole balance would be paid off in just a year. It’s that much faster.

Improve Your Credit Score

If you’ve read our previous blog post, then you know how important credit scores are. If you’re looking to do things like apply for a mortgage, buy a car or even move into a rental property, your credit score will play a big part in whether you’re accepted or not.

A big part of working out your credit score is looking at your current credit utilisation ratio – how much of your available credit you’re using. In other words, what’s the ratio of your credit card balances compared to your credit card limits. If you’re right up against your credit limit all the time, you will have a high credit utilisation ratio, and if you’ve got a lot of breathing room, it will be lower. The more of your credit card debt you pay off, the better your credit utilisation ratio will be. As a general rule, you want to keep your total ratio for each credit card below 30% if you can, as this represents a health credit utilisation and a low-risk candidate for lending.

By the way, your credit utilisation ratio makes up around 30% of your total credit score, so it’s worth making the effort to pay it off!

At Chilvester Financial, we believe that understanding how your credit works, and how best to manage it, is an important part of managing your financial health and planning for your future. That’s why our advisers not only support you in the big decisions and plans, but the little ones as well. If you have any questions – big or small, we are always happy to help. Just get in touch with us today for your free, no obligation consultation.