The minimum repayment on your credit card refers to the minimum amount you need to repay each month to stay in ‘good standing’ with your credit card provider. Credit card companies encourage their customers to make the minimum monthly repayments, because that way they can charge you more interest, for a longer period of time, on your outstanding debt. That is one way credit card companies make money off their customers. In this post, I want to share with you 3 reasons why you should always make more than the minimum repayment on your credit card.
You get out of debt quicker
The more you repay of your credit card debt each month, the faster you will get out of debt. For example, if you make the standard minimum repayment of 3% each month, of outstanding credit card debt to the value of $12,000 with a 20% APR (and a minimum repayment amount of $50), it would take you 207 months to pay back your outstanding credit card debt. That would be 17 years and 3 months. If instead, you would repay $400 each month, then the time it would take you to repay your credit card debt would fall to 42 months, which would be 3 years and 6 months. You can play around with our Credit Card Payments Calculator if you want to find out how much you need to repay each month to pay off your credit card debt within your desired time horizon.
It improves your credit score
The faster you manage to pay off debt, the better for your credit score. 30% of your credit score is made up of the amounts you owe. Hence, if you can lower your credit utilization ratio (i.e. the percentage amount of debt you owe compared to your available credit lines) and your absolute amount of outstanding debt, the better that is for your credit score.
It decreases the cost of your debt as you pay less interest
Finally, paying more than the minimum repayment also decreases the cost of your debt, as you end up paying less interest on your outstanding credit card debt. When it comes to credit card repayments interest costs make up a large chunk, as credit cards usually have high interest rates. Hence, the more you pay off each month, the lower your overall interest costs will be.
For example, if you have $5,000 of outstanding credit card debt with a 25% APR, and you repay $150 each month, then it will take you 58 months to repay your debt and out of the repaid amount $3,625.49 will be purely interest payments. However, if you instead decide to repay $250 each month, then it will only take you 27 months to pay it all off and out of the repaid amount only $1,535.41 would be interest cost. So, by paying more than the minimum, in this example, you have more than halved your cost of the debt on this credit card.