Minimum Due on Credit Cards

Maya was 23 when she got her first credit card. Fresh out of college, she was just adjusting to adulting. Although she had bagged a job for herself, she wasn't earning a lot.

Maya worked hard to make ends meet. After paying rent, utility bills and other basic expenses, she barely had anything left. Her expenses shot up in her birthday month, when she not only pampered herself with a few lovely gifts but also threw a party for her friends, cousins and colleagues.

Her credit card bill was way more than what she could afford. Ignorant of how the mysterious world of credit cards works, Maya found an easy solution to the looming problem - she chose to make the minimum payment and decided to handle the remaining balance in the next month. Her next credit card bill hit her with a huge shock.

Like Maya, many credit card users are oblivious to the intricate mechanisms of the credit card payment system. When you only pay the minimum amount due on your credit card, you aren't really solving a problem - it's just temporary relief. In reality, you are committing to repay more in interest charges and taxes later on. Such a trade-off can get you into grave financial trouble over time, especially if your card charges a high interest rate.

What is Minimum Due?

The minimum due on credit card is the bare minimum bill amount that you have to settle each month to evade paying penalty charges. While some lenders fix a flat amount as 'minimum due,' some others calculate it as a certain percentage of the outstanding credit balance in a particular billing cycle.

If your bill amount for January is Rs.10,000, and the minimum due is 5% of your outstanding balance, then you just need to pay Rs.500 within the due date to avoid late payment charges. The minimum amount due is much lower than the total outstanding due. Convenient and affordable, right?

What's the Problem?

Well, many fail to recognize the danger hidden behind the garb of convenience. You might manage to escape the late fees by paying the minimum due, but the remaining outstanding amount will get heftier in the next billing cycle due to the addition of interest and taxes. Before you realize it, you might slip into a deadly credit card debt trap that can escalate rampantly, ballooning the debts out of proportion within a blink of an eye. Let's explore why.

Time Trouble

When you are making just the minimum payment on your credit card, you're basically telling your debt, "See you next month."

Credit card issuers usually set the minimum payment requirements at rock-bottom levels. As I've already mentioned, you'll either be required to pay a fixed amount or a percentage of the outstanding balance. Some credit card companies require you to pay barely 1% or 2% of the credit balance each month, along with any fees and accrued interest.

Making such tiny amounts of payment on time will definitely keep you safe from late fees, but you will hardly make any real progress on repaying your balance.In fact, if you keep paying the minimum due each month, it'll take you years to pay off the debt. Moreover, you can easily end up paying more than double the amount you had actually borrowed. You pay, and you pay, and you pay, but you never pay it off.

The best way to avoid this mess would be to settle all your current dues within the current billing cycle. If a tight budget impedes you from doing so, pay off as much as you can - paying at least the double of your minimum due will reduce the debt burden to a large extent.

Incredible Interest

Credit card interest rate is an enigma. We all know that credit cards are accompanied by notorious APRs (Annual Percentage Rate), but we barely know how to calculate credit card interest rate. Credit card APRs are usually in double digits; it can be as high as 30-35% per annum. Credit card users are charged interest only when they carry a credit balance from one month to another.

So, if you're paying your credit card bills on time, you wouldn't have to pay any interest at all. However, if you are simply paying the minimum due, the hefty APR applies to the remainder. The longer and the heftier outstanding balance you have, the more is the interest payable. Additionally, a GST of 18% will also be applicable to the amount. And don't forget, credit card interest is compounded. You'll be buried deep in debt even before you realize!

So, unless you're using a credit card with 0% credit card APR, your interest charges will rise along with your rising outstanding balances. Making only the minimum payment will barely wipe out your last month's interest. And assuming that you keep using the card every month, your outstanding balance will pile up, attracting a huge amount of interest and taxes, and you will fall further and further behind in settling the amount.

Credit Catastrophe

Although you have a credit limit of Rs.1 lakh, you are expected to keep your expenses (technically known as credit utilization ratio) within Rs.30,000, i.e., 30% of the credit limit. Credit utilization ratio plays a major role in determining your credit score. If your credit balance rises, so does your credit utilization ratio, and your credit score takes a hit. A serious blow to your credit score can take years to repair.

A bad credit score can mess up your life - it will not only be harder for you to qualify for new lines of credit, but it can also affect your ability to find a job or get a new phone connection or rent an apartment, as employers and service providers often review your credit score to evaluate your credibility.

To Sum Up

Credit card companies aren't giving you "free money;" neither are they your friends. They are in the big game of making money. Lenders often obfuscate important details, camouflaging the deadly consequences of certain actions with lucrative offers that tempt you to indulge.

Don't be gullible enough to step into this quagmire of credit card debt. Stay aware, stay informed, and settle all your dues in time. Do not forget to check your credit score regularly to keep track of how well your efforts are paying off.