Avoiding the credit card 'minimum payment' trap

Avoiding the credit card 'minimum payment' trap

Every credit card bill you get will tell you the total amount you owe on your account, and the "Minimum Payment Due".

Unless you pay the total amount due, you will be charged interest.

You seem to have two choices offered - pay the full amount, or pay the minimum amount due.

Of course, you can always pay any amount in between.

If you choose to pay the minimum amount stated - BEWARE. You are choosing an incredibly expensive option.

Credit card statements rarely reveal the bank's minimum payment rules for easy reference. In the table to the right below we have provided some links.

But even after reading those, you are unlikely to realise the full extent of the costs you are setting yourself up for.

The real problem is that minimum payment amounts are generally set too low. They look good, and are easy to choose without breaking the credit card company rules*.

But they are a trap.

Each time you make a minimum payment, almost all goes to pay the interest incurred and only a tiny fraction goes to pay the purchases you charged (the proportion depends on your credit card rules). And each month (if you don't add any new purchases) the minimum amount due falls by a similar small fraction.

The result is, just paying minimum payment amounts could mean you will take 50+ years (yes, years) to pay off your original purchase, and the interest you will have paid will be vastly higher than that original purchase.

This calculator shows the impact of the minimum payment choice.

It uses each bank's specific card payment rules.

Notice that the more you owe, the longer it will take to pay it off.

Minimum payment amounts for standard credit cards range from  2% of the closing balance (ANZ, BNZ, Westpac) to 5% (Kiwibank, TSB). All banks also have a minimum $ amount that will apply, ranging from $5 (ANZ and Westpac) to $25 (BNZ).

Bigger is always better - no exceptions.

And this is why.

A $2,000 charge on an ANZ or Westpac standard Visa or Mastercard , if you pay it off at the bank's minimum payment amount, will take 60 years to clear, and you will have paid $10,910 over that time. That is outrageous in our opinion, and a slam-dunk reason why you should never just pay the minimum amount.

  minimum payment ...
  greater of or
   -----------  ----------
ANZ - see clause 9.2 2% $5
ASB 3% $10
BNZ 2% $25
Kiwibank 5% $10
National 3% $10
TSB 5% $10
Westpac 2% $5

On a similar basis, with the BNZ, you will take twenty years and it will cost $7,142 for that $2,000 original purchase.

For the National Bank, it's 15 years 3 months, paying $4,228.

For the ASB, it's 14 years ten months, paying $4,109.

For Kiwibank, it's 7 years and 7 months, paying $2,870, and for TSB its 7 years and 3 months paying $2,749.

There is a huge difference between ANZ and Westpac on one hand, and TSB on the other.

But let's not disguise the fact that taking seven years to pay off a credit card debt is a rubbish thing to do.

If you are just paying the minimum payment, chances are you have also been adding to the amount you owe with additional purchases. If that is the case, you are going backwards fast and in an even worse situation.

Use this calculator to set a target to pay it off in a reasonable time period. Rule #1 - don't add anything more to the card. Rule #2 - stick to the higher payment amount you choose.

Unless you pay them off in full each month, credit cards are generally a poor funding choice. Banks find their credit card divisions are among the highest returning parts of their business - and that's because of the types of figures we have set out above.

----------------------------------

*   Banks argue that you should use the minimum payment facility occasionally, and only when absolutely necessary. But when have you heard a bank actually advise that?

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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Noone would dispute the wisdom of your advice re CC.  However, lets look at solutions for a household who is/are on flat NZ wages, e.g. Dad's on 50k, Mums on 20k - mortgage of 250k, with 3 credit cards on 5k, 10k and 12k - built up over the years due to rising costs and flat wages - and 3 or 4 expensive kids.

Solution1: Topup the mortgage by 27k and pay off the CC - now it may take 15-30 years to pay off what was on the CC. (Some advisors warn this is converting unsecured to secured debt). Requires equity under 80%.

Solution2: Bite the bullet, live on the oily rag - and try to pay extra on 1 CC, while paying minimum on the others  -   ie the snowball effect. Grind it out over 4 years, sell stuff on Trademe etc.  

Solution3: Sell the house, pay off everything, rent for a while, re-buy a house (if possible now with less equity after the RE fees, Lawyers, Bank break fees etc) and start with only mortgage debt.

4: Retrain & push for higher paying jobs or run a business.  

Uhmm... any other options - other than don't use CCs in the 1st place.

This is the debt trap many households are in. How deep can they cut?  Electricity? Gas? Phone? Internet (kids need for school)? Car? Petrol? Rates? Mortg?  Once they're in the trap of maintaining a household, mortg, kids etc there are few options - & the CCs just get them in deeper.   Then the banks feign shock horror & deny many a housing loan - even though they pushed the CC debt onto them.  

Another option

1. Consolidate the CC debt with a company like Instant Finance. Lower interest rates.

Change to a bank which offers a very low rate on existing CC debt if you transfer then change to an Instant Finance afterwards.

I am happy with the status quo, I pay my CC off in full every month. If people pay the minimum off, it is more likely CC companys will keep the 55 days free credit if the majority do not pay off the balance. That is where they make the money, 20% plus interest on outstanding balance.

Also, tell the kids to get a part time job if they want designer clothese or shop at The Warehouse, No 1 Shoe Warehouse & K Mart.

Also, user beware, the banks are not your parents or nanny so they will tell the minimum needed about fees and interest so yo maximise their interest.

I'm sure this is what alot of folks do, but we've got a revolving credit mortgage and use our credit card to basically gain the rewards and save us a small amounts of interest on our mortgage.

Our CC limit is set at our total expenditure for the interest free period.

EG we pay all bills and purchases on the credit card.

So over a 3 month period we'll spend approx $5k. Limit is $5k

Every fortnight we get paid we whack about $800 onto the visa to make sure we don't pay any interest. Save a bit on interest on your mortgage and pay no interest on your credit card. Works for us.

 

From the "Uh duh!" department:

"Notice that the more you owe, the longer it will take to pay it off."

If we previously had any doubts about just how stupid BH and Co think we really are, they have now been thoroughly dispelled.

We learnt compounding interest rates in 5th form.... people who understand interest earn it. people who don't understand interest, pay it.