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For many years, creditors typically asked that you pay about 2% of your outstanding balance. That was a great way for them to get rich, because it meant you’d be a customer for life, taking many years to pay off goods and services you charged ages ago. If you can swing it, I recommend always paying at least two, preferably three times the required minimum amount due.
In early 2006, some of you may have noticed a change in your credit card bills. The minimum payments your bank required went up. What happened is that regulators got really concerned about consumers being caught in a cycle of debt as a result of only making minimum payments on their credit cards. Therefore, the Office of the Comptroller of the Currency mandated that banks force you to pay a minimum payment that would knock out not just interest, but also some of the principal balance due on your credit cards. The result is that most of the major credit card companies raised their required minimum payment from 2% to 4% of your balance. Financial institutions, including Bank of America, MBNA, and Citibank announced that they were doubling the minimum payments required by their customers. This means just two years ago, you might’ve been paying $500 a month on your credit cards. Now, the minimum payments on those credit cards have skyrocketed to a total of $1,000 monthly.
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 also required credit card companies to put a notice on your monthly statements saying how long you’d be in debt if you only make the minimum payments.
For some of you, I have no doubt that when you wake up and start to see how long you could be financially beholden to a credit card company, it will be a huge shock to your system. Even more to the point, some of you may be scared witless at how much your credit cards payments keep going up – especially if you’re not seeing the balances go down substantially.
Well, there’s good and bad news to this whole new era of higher minimum payments. The bad news is that you may have to do some serious belt-tightening in order to afford to make your credit card payments and juggle all your other monthly bills. If you’re having troubles, you could try to negotiate a lower rate to give yourself some breathing room. (See my negotiating tips in Day 5). You might also consider tapping the equity in your home, if you’re a homeowner, to pay off high-rate credit card debt with lower-rate mortgage debt, which is tax deductible. Before taking this route, though, be sure to read by advice on this topic in Day 23. Only certain people should swap credit card debt for mortgage debt. And if you’re not careful, this strategy can backfire. The good news about higher credit card minimums is that by forcing you to cough up bigger chunks of money in the short run, they will get you out of debt faster in the long run.
Minimum Payments Now Really Equal Maximum Payments, in the Long-Run
Paying so-called minimum payments now actually ends up costing you more – a lot more – over the long haul. The math behind some of the calculations that determine your interest rate can be tricky. And I won’t get into all the complex, and sometimes mind-boggling formulas that are used to calculate your Annual Percentage Rate (APR). But suffice to say that for every $1,000 you owe, if you paid a minimum of say 4%, you’d only be paying $40 a month. With just $2,500 in debt on a card with an 18% interest rate, you’d spend 10 years paying it off and you’d pay more than $1,400 in finance charges on top of what you originally spent.
A Guaranteed Investment Return
Many charge cards carry very high interest rates of 18% to 21%, or more. If you carry large credit card balances, that’s a drain on your monthly finances. At the very least, start doubling up on your payments in order to pay off those credit cards sooner, rather than later. If you pay off a MasterCard that is charging you 21% interest, that’s the equivalent to earning a guaranteed 21% investment return – and you won’t find that kind of guarantee anywhere in the stock market.
But I Don’t Have the Money!
I know some of you may be saying: “I don’t have the money! If I had the money to pay three times my minimum balance – or even all of it, I would’ve done it by now!” Well, keep reading – particularly in Day 15 through Day 24 – for ideas about how you’re going to come up with the money to ultimately achieve Zero Debt status. For now, to get you on track, I want you to write a check this day to pay more than the minimum due on one credit card that you owe. I don’t care if it’s a $5 check. Just pay extra money on any one bill right now. It can be on a card you’ve already paid this month or an upcoming bill. But mail that check today!
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Lynnette is a personal finance expert, author and speaker.