Whether you receive a credit card statement online or in the mail, you may be surprised by the way the minimum payment due fluctuates each month. The minimum payment is the least amount you can pay without incurring a late fee and perhaps an increase in your interest rate.
Credit card issuers can decide how your minimum payment is calculated as long as they follow the guidelines set by the Credit Card Accountability Responsibility and Disclosure Act of 2009, says Linda Sherry, director of national priorities for Consumer Action, a consumer advocacy group headquartered in San Francisco.
Generally, you’ll pay either a minimum flat fee or a calculated amount based on your balance.
How Minimum Payments Are Calculated
Your minimum credit card payment depends on the size of your balance and your credit card issuer’s rules. If you owe a tiny amount on your credit card, such as $25 or less, you usually must pay that in full.
“Every credit card issuer has a ‘floor’ for the minimum payment, such as $20 or $25,” says Sherry. “If your balance is less than the floor, you’ll have to pay it in full. If your calculated minimum is less than the floor, then you’ll pay the floor amount.”
The most common floor for credit cards is $25, according to a 2015 study by the Consumer Financial Protection Bureau, or CFPB.
The formula for how your minimum payment is calculated can be found on your cardmember agreement, says Peter Klipa, vice president of creditor relations for the National Foundation for Credit Counseling in Washington, D.C.
[Read: The Best Cash Back Credit Cards of 2018.]
You’ll receive a copy of the cardmember agreement with your credit card and an updated copy if there are changes to the agreement. You may be able to view it online, depending on your credit card issuer. You can also request a paper copy of your cardmember agreement at any time.
There are two common methods used to calculate your minimum payment when you carry a balance:
— Flat percentage: The simplest method, one used most by credit unions and subprime banks, according to the CFPB, is calculated as a percentage of your total statement balance including finance charges and any fees. Credit unions typically charge 2 percent of the total balance, the CFPB says, while subprime issuers are more likely to charge 5 or 7 percent of the balance as a minimum payment. The minimum payment of 2 percent on a balance of $2,500 would be $50.
— Percentage plus fees and interest: Most larger credit card issuers use a formula for your minimum payment based on 1 percent of your total balance excluding finance charges and fees, according to the CFPB. Then the fees and interest accrued during that billing cycle are added to the minimum balance due. For example, a balance of $2,500 at 15 percent interest would have a minimum payment of $56.25 because 1 percent of the balance would be $25 and the interest charged would be $31.25.
“In addition to the minimum payment required as a percentage of your balance, if your previous month’s payment was late, you’ll pay a late fee,” says Klipa. “If you didn’t pay the previous month at all, your minimum payment will also include the past due amount.”
Your minimum payment can also include an over-the-limit fee or some or all of the over-the-limit amount if you have exceeded your credit limit. However, the CFPB study found that while most credit card issuers include late fees and past due amounts in their minimum payment requirement, the majority don’t include the amount you owe above your credit limit.
Government Guidelines for Minimum Payments
An important element of the CARD Act, says Sherry, is to discourage credit card issuers from setting their minimum payments so low that borrowers incur negative amortization. If the minimum payment set by the credit card issuer results in negative amortization, that must be disclosed to the borrower. Negative amortization occurs when your balance on a debt grows because you haven’t paid enough to cover the accrued interest.
“Minimum payments are designed to keep you in debt longer and for financial institutions to get more interest out of you,” says Sherry. “One reason the government passed the CARD Act was because minimum payments had shrunk so much they weren’t even covering new finance charges.”
The CARD Act requires credit card companies to give customers a 45-day advance notice of an increase in the minimum floor payment. In addition, the CARD Act specifies that you can’t be charged an inactivity fee if you don’t use your credit card.
If you decide to close your account or cancel your credit card, the CARD Act allows credit card issuers to require that you pay off the balance in five years and to double the percentage of the balance used to calculate your minimum payment.
[Read: The Best Balance Transfer Credit Cards of 2018.]
Minimum Payment Warnings
If you pay only the minimum amount due on time every month, you won’t see a direct negative impact on your credit score, says Klipa, but you’re choosing a very slow way to pay your debt and will carry a balance for a long time.
“Thirty-five percent of your credit score is based on your payment history, so on-time payments are extremely important,” says Klipa. “Thirty percent of your credit score is based on the amount you owe in comparison to your credit limit. Paying only the minimum won’t reduce your debt very quickly. In addition, if you consistently pay only the minimum, other lenders may see a pattern of not managing your debt.”
If you carry a balance on your credit card, the CARD Act requires your credit card company to include a minimum payment warning that shows the payment required to pay off your debt in three years. For example, if you paid only the minimum on a credit card balance of $2,500 at a 15 percent interest rate — it would start at $56.25 and then decrease — it would take almost 16.5 years to pay off the balance, and you would pay approximately $2,600 in interest. If you paid $89 per month and didn’t add new charges, that balance would be repaid in three years, and you would save about $2,000 in interest.
Your statement must show how long it will take to pay off your balance if you only pay the minimum and how much total interest you will pay. The warning demonstrates how much faster you can get out of debt if you pay more than the minimum.
“Never ever pay just the minimum amount due,” says Sherry. “Paying more than the minimum eats away more of the balance, so it’s important to pay as much as you can comfortably pay. The result will be less interest accruing and a lower balance going forward.”
While paying your balance in full is best to avoid accumulating interest and to improve your credit score, Sherry suggests using an online minimum payment calculator to see how long it will take to pay the debt and how much interest you’ll pay over time depending on how much you pay each month. That calculation can help you decide how much you should pay each month toward your balance.
What To Do When You Can’t Pay the Minimum
If you’re struggling financially, it’s important to pay the minimum amount by the due date to protect your credit. But if you can’t make the minimum payment, contact your credit card company as soon as possible. As part of the minimum payment warning, credit card companies are required to include a toll-free number for credit counseling services.
[Read: The Best Rewards Credit Cards of 2018.]
“Most banks have an internal counseling program to help customers with their specific credit card debt,” says Klipa. “If you have multiple credit card debt issues, your bank can recommend an NFCC credit counselor who can look at your financial situation holistically and provide budget advice. If necessary, we can work out a debt management plan based on a monthly payment that fits your budget.”
Since credit card debt is unsecured credit, you’re not in danger of losing your home or your car as you might if you can’t pay a mortgage or car loan. However, not paying your minimum credit card bill will damage your credit score. Your credit card company could send your bill to a debt collection agency who can hound you for repayment, says Sherry.
“You can try to negotiate with your credit card company to pay less than you owe, especially if you have a hardship,” says Sherry. “But if they forgive some of your debt, you’ll need to pay income taxes on that portion of your debt.”
Your Consumer Rights and Payment Calculations
While the CARD Act provides some protections for consumers, credit card companies have the right to change the way your minimum payment is calculated.
Understanding how that minimum required payment on your credit card is calculated requires reading the fine print in your cardmember agreement, but at least you’ll have a better sense of why your payment fluctuates. Your credit card statement includes clear information about the consequences of making just the minimum payment, including how long it will take you to repay the debt and what it will cost in interest expenses. Using that information wisely can help you manage your credit card debt and improve your financial position.
More from U.S. News
Complete List of Credit Card Fees to Watch Out For
What Happens When You Pay Your Credit Card Late?
A Guide to Eliminating Credit Card Debt
What You Should Know About Your Minimum Credit Card Payment originally appeared on usnews.com
