Credit cards – the minimum payment trap

Do you only make the minimum payments on your credit cards?

If money is tight, you may feel you can’t afford more…

But do you know that there is a simple alternative that will speed up debt repayments a lot, not harm your credit record and not cost you any more?

Repaying a credit card with minimum payments

How long does it actually take?

Suppose you buy a cot and a buggy costing £1,030 on a credit card.

It’s at a rate of 18.9% and the minimum payment will start at £25 a month – that’s using pretty common minimum repayment rules.  You think that sounds OK.

Here is how long Barclaycard says it would take to repay that £1,200 if you only pay the minimums:

So it will take nearly 19 years to finish paying for that baby equipment. And you will have paid more in interest than what you bought.

I choose Barclaycard as it is one of the most commonly used. The average time across all credit cards was found in research to be 18 years and 9 months.  So Barclaycard is very close to the average.

Here is Barclaycard’s minimum payment calculator. If you borrow more or at a higher interest rate it will take even longer.

Most people really underestimate how long it takes

An academic paper asked 1,700 people how long it would take to clear a similar debt to my example. This found that:

• 38% said under 3 years
• 65% said under 5 years
• 85% said under 10 years.

A lot of people’s first reaction when they are told how long it takes is that 19 years is ridiculous and it shouldn’t be legal.

Making minimum payments to a credit card is a trap!

Paying the minimum to credit cards or catalogues takes an astonishingly long time to pay off a credit card.

Most of your payment is just paying the interest, only a little is repaying the money you owe. With many credit cards that repayment amount is set at 1% of your balance per month.

But the real problem is that because you will have paid off a tiny bit of the balance, next month the 1% balance part will reduce. So your next minimum payment is a little bit less. Not enough to really help you, you probably won’t even notice it.

You might think that’s good – but it is actually a trap!

You are paying off less of the balance every month. So the time to clear the balance stretches out and you are kept paying interest for longer.

How to get out of the trap

Regulators suggest you should pay more

The FCA, who regulates credit card lenders, says that lenders have few incentives to help you get out of debt sooner because this lending is so profitable.

The FCA is making banks and card companies write to people who have been making minimum payments for too long and suggest they should pay more.

After three years of making minimum payments, if you can’t afford to pay more, the lender has to look at options such as lower interest rates, charges and fees. See this case where Halifax cut a customer’s interest rate and a couple of month later said she had to start paying a recommended amount that was larger than the minimum payment or they would stop the card.

So what can you do to get out of this trap? It would be great to be able to pay off your whole bill in a few months, but for many people that isn’t realistic.

If you can’t afford to pay much more – start paying a fixed amount!

If you are thinking I can only afford the minimum amount you can choose to always make your current repayment, instead of letting it drop a little bit each month.

This is a simple approach, which won’t cost you any more, but which can make a dramatic difference.

Use the above example – you have a £1,030 balance on your card. The Barclaycard calculator has a “fix your payment” button you use to see what effect this has.

If you decide to fix your monthly card payment at £25, your current minimum payment:

• it will take you 5 years and 4 months to clear the balance
• you will have paid only £557  in interest.

Doing this isn’t going to cost you any more now, but it will take 13 years off the time you are paying interest, and mean you pay less than half as much interest.

So if you can switch to paying a fixed amount instead of the minimum, it’s not going to be expensive for you, but you will be out of debt many years sooner.

Paying even a little bit more has a surprisingly large effect

Can you afford to pay an extra £2 a month, so £27 to that £1,030 balance? Fixing your payments at that level will mean your credit card balance is paid off even faster:

• it will take you 4 years and 9 months to clear the balance
• you will have paid £487  in interest.

How to “fix a payment”

Some credit cards let you set a monthly payment at an amount, and they will automatically take that amount by direct debit unless your minimum is higher, in which case they will take the minimum.

If your card doesn’t have this option, you can decide not to use a direct debit but set up a standing order to do this. Your credit card will tell your their sort code and bank account number to use – and you normally use your card number as the “payment reference”. But if you use the standing order approach, you HAVE to stop using the card. Otherwise your minimum payment may increase and your standing order payment will be too low and your credit score will be harmed.

If you get paid monthly, it could also be good to pay the credit card as soon as you are paid, so that money is never in your account and you can’t spend it by accident.

A good idea even on 0% cards!

If you have a card you are currently paying 0% on, it’s still a good idea to fix your repayments, preferably at more than the current minimum. The ideal is to fix the payments at an amount that will clear the balance by the end of the 0% period.

It is getting harder to get good 0% balance transfer deals. They are getting shorter and the credit limits are being reduced. So the more you can pay off the balance, the less chance there is of problems at the end of the 0% deal.

Also paying more than the minimum is shown on your credit record and can increase your chance of getting credit in the future.

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