Credit cards can be a highly convenient tool for facilitating daily transactions and managing personal expenses. They can also earn financial rewards, get free credit scores, secure payments from fraud, and get valuable benefits like purchase and price protection.
However, if they are poorly managed, they can quickly become a financial burden. As bills rack up, cardholders may be unable to pay little more than the minimum required monthly.
Paying the minimum required monthly balance on your credit card may seem simple and innocuous to manage your finances. This method can even offer a reprieve from financial strain. Paying the minimum means you're current on your bills and helps maintain your credit score.
However, it is a deceptive comfort, and you should never underestimate its impact on your long-term financial health. Left unattended, it can give rise to a list of hidden dangers that affect your future creditworthiness and ability to get out of debt.
The Downsides of Paying Only The Minimum on Credit Cards
Sometimes, people have no choice but to accumulate bills and pay them off in small installments instead of in bulk. Certain life events may force you to use your credit card as an emergency fund.
In this case, minimum payments are acceptable for a short period. Understandably, you could only make the minimum on your credit card payments for a specific time frame.
However, extending this practice or making it a habit could hurt you in multiple ways. The following are the downsides of making only the minimum required monthly payments on your credit cards:
The debt snowball effect
Credit card companies make money on interest. Therefore, they are okay with your minimum payments. It means more interest accrues against your balance the longer you sustain it. You should recognize this disadvantage because it means you are losing money on interest.
Credit card companies charge anywhere from 15 to 25 percent interest and could even go higher, depending on your creditworthiness and the card's program. By paying only the minimum, you are letting the interest on your debt compound with the balance. You set the stage for debt accumulation and the snowball effect. Unchecked, this situation could get out of control quickly.
Damage to your credit score
Multiple factors influence credit scores. The most critical factors are your credit utilization and payment history. Credit utilization is the amount or percentage of your total credit utilized at once. Credit scoring models evaluate the ratio of your credit card balance to your credit limit. Payment history refers to the timeliness of your bill payments.
High credit utilization could indicate financial distress and thus lower your credit score. Your diminished creditworthiness will affect your ability to lock in favorable interest rates on mortgages or other loans.
Obtaining emergency loans could be more difficult, leaving you vulnerable to predatory loan products that lead to more significant financial distress. A low credit score could also prevent you from borrowing money altogether, leaving no room for financial relief when needed.
Racking up penalties
When facing financial constraints, individuals often opt for the minimum payment. Therefore, the potential for late payments is also high. When there is little room for error, late payments can trigger penalties and unexpected fees. Such charges further add to your financial burden. The accumulation of late fees creates a vicious cycle that makes it harder to escape credit card debt.
Prolonged repayment period
Minimum payments extend the debt repayment period. The longer it takes to clear your outstanding balance, the higher your interest may go. In addition, the extended repayment period restricts your opportunities. It ties up your money to debt payment instead of allocating it to profitable investments. You miss out on the chance to grow your savings.
How To Break Free From the Minimum Payments Cycle
Recently, credit card balances in the United States reached a 10-year high. TransUnion's (NYSE: TRU) data, released on November 9, 2023, shows that the average credit card account in the US carries a balance of $6.088. This amount is up by 15% compared to last year's period.
Moreover, ...