If you make the minimum repayment on your credit card every month, eventually you will find yourself paying back less and less each month until you finally clear all of the debt.
But bear in mind that sticking to the credit card’s minimum payment option can be one of the most expensive ways to manage your credit card bills.
When you apply to take out a credit card you will (or at least, should) read the credit card’s summary box, which provides a breakdown of all the costs, charges and other conditions attached to the credit card.
One of the boxes will display the rules relating to the credit card minimum repayment. This will often be written as a sentence, like so:
Minimum repayment: An amount equal to the total of interest, default charges and 1% of the balance shown in your statement (minimum £5, or the full balance if less than £5).
The minimum amount may vary, but generally you would owe the interest, any default charges, plus a percentage of the remaining balance or a fixed minimum amount, whichever of the two is highest.
Elsewhere in the credit card summary box is the section relating to the interest free period. If you are able to take advantage of the interest free period, then make sure you do so. By repaying your credit card balance in full within the interest free period you avoid paying any interest.
It also means that your credit card will not have cost you anything as you have used it in a similar fashion to how you might use a debit card. Just make sure you avoid withdrawing any cash with a credit card as there is rarely an interest free period on credit card cash withdrawals. In fact you will almost always be charged interest daily from the moment you take the money out.
In the credit card summary box you will see the interest free period information written a little like this:
Interest free period: Maximum 56 days for purchases if you pay the full balance shown on your previous and current statement on time. No interest free period on cash withdrawals and balance transfers.
This essentially means that for 56 days (this period varies between credit card providers but is generally between a month and two months long) you can make purchases without incurring any interest charges provided that you have paid the previous balance in full and on time.
You would also need to pay off the current balance in full within those 56 days or interest will be added to the balance.
But what happens when you don’t pay off your credit card balance in full and don’t repay it within the interest free period? In this guide we explain just how expensive credit cards can be, how to reduce the amount of interest you pay, even if you are only just about scraping by, and how you might be able to save money by taking out a balance transfer credit card.
How expensive are credit cards?
In order to understand how expensive credit cards are in relative terms, it’s important to look at the annual percentage rate (APR), which is essentially the cost of borrowing. When comparing a variety of loans and credit products there will be an APR included in the comparison tables to help you decide which product is cheapest.
When comparing loans and mortgages, you might find that the APR can be somewhere around 3% to 7%. This is considerably lower than most credit cards, which can have an APR of somewhere in the region of around 15% to 45%. However, you are likely to be borrowing much less on a credit card at any one time than you are if you have taken out a loan or mortgage.
Relatively speaking though, credit cards are more expensive. You will always have larger debts on a mortgage, but this is more to do with the fact that you are borrowing a far higher amount. On a credit card, even with debts under £100, they can quickly accumulate to become far more expensive (again, relatively speaking) if you only pay the minimum every month.
So how does credit card APR work exactly? The minimum payment on a credit card will usually include the cost of one month’s interest.
The APR is based on the annual cost of interest, but if you only made the minimum repayment on your credit card each month, this cost would have to be paid monthly.
The monthly cost of interest is usually the total APR divided by 12. This interest is also usually not compounded, so your monthly credit card interest may seem low, but if you don’t repay it in full the interest will accumulate interest. The APR you see listed next to a credit card is the interest cost when it has been compounded.
So you might see that your credit card has an APR of 21%, but your interest each month will be 1.6012% rather than what you might get if you divided 21 by 12 (1.75%). Using this example, we can calculate how much you would pay each month if you only made the minimum payment on your credit card.
What is the minimum payment on a credit card?
As mentioned previously, the minimum payment on a credit card can vary but it is typically the highest of the total balance under a fixed amount (£5 for the purpose of this example), or the interest and any default charges for that month.
So to make things easier to work out, let’s say you have a credit card with an APR of 21% and a debt of £100. How long would it take to pay it all off if you only made the minimum repayment each month? In this example, we’ll also apply the rules of the credit card we used earlier, which has a minimum repayment rule of 1% of the balance plus interest or the total balance if under £5.
Credit card minimum repayment calculator
If you were paying off £100 of credit card debt with a minimum repayment each month it would take you 25 months and you would have paid £21 in interest (21%). For the length of the time it took, you may not find the interest payment that high, but what if you had borrowed £1,000 on your credit card?
Using the same rules above, it would take you 18 years and 9 months to repay your credit card balance of £1,000 by making a minimum repayment. On top of that, you wouldn’t have just taken nearly 19 years to pay off £1,000 but you would have also paid a massive £1,402 in interest alone, putting your total repayments at £2,402.
However, simply increasing the amount you pay each month can massively reduce how much credit card interest you pay compared with just paying the minimum amount.
Using the example above, if you simply paid £20 every month instead of the minimum, you would have repaid the debt in 8 years and 6 months instead of 18 years and 9 months. Stretch it to £40 and you would have paid it off in 2 years and 9 months and paid £1,030 in interest instead of £1,402.
Direct debit instead of minimum repayment
One of the simplest ways of reducing the amount of debt you have on your credit card is to set up a direct debit from your bank account to repay a fixed amount each month. Instead of making a minimum payment towards your credit card bill, set up an affordable amount that you can realistically keep paying every month until the debt is cleared.
Obviously, consider the fact that the more you pay, the quicker your debt will get cleared, so try to be as disciplined as possible. A few pounds extra each month from your direct debit to your credit card bill can save you plenty of time and money in interest payments.
If you can’t afford to pay more than the minimum from your direct debit, try not to panic. You can top up your minimum repayment with more money if you manage to find you have some left over.
Cut your credit card interest
Another way of reducing the amount of debt you have on your credit card is to contact your credit card provider and ask if they will reduce your APR for you.
It’s obviously not always in the credit card companies’ best interests to cut the amount of money you owe them in interest, but remember there are factors that could be working in your favour.
The credit card industry is a competitive market and there are plenty of deals available to new customers offering low interest rates, cashback, airmiles, travel benefits, 0% on purchases and more. Credit card companies would rather you owed debt to them than their competitors.
If you have a good credit rating and have never missed a payment with your credit card provider, and have been with them for a while (say, at least longer than 6 months) then it wouldn’t be unreasonable to ask if they will cut your interest rate. If they won’t do it, then think about moving on and getting a balance transfer credit card.
Should I get a balance transfer credit card?
If you have debts continuously accumulating on your credit card and you are struggling to make a significant dent with your repayments, then shopping around for a balance transfer credit card could be a good option for you.
Remember, if you are only making the minimum credit card repayment each month, a balance transfer credit card is unlikely to have an impact on your debt repayment capability.
A balance transfer credit card is a credit card that can pay off the debt on a different credit card. It transfers the balance to your new credit card, and instead of owing the debt to your old credit card provider, you will now have to pay back the new credit card provider. Balance transfer credit card deals usually entice new customers with a 0% interest offer.
These can last for around 6 months all the way up to nearly 3 years, giving you plenty of time to repay the debt without incurring added interest. However, you will have to pay a balance transfer fee for the privilege of getting one of these credit cards. The balance transfer fee is typically anywhere between 1% and 4% of the balance you are paying off.
So for example, if you have debts of £3,000 on your credit card and want to transfer it to a new balance transfer credit card with a transfer fee of 3%, you would have to pay £90 up front. After that you will be allowed to repay the debt interest free during the offer period.
However, balance transfer credit cards revert back to an often high rate of APR after the 0% interest free deal period ends, so make sure to plan your repayments in a way that clears the debt within that period.
But if you have to pay a transfer fee is it still cheaper to get a balance transfer credit card? Of course, it is cheapest to pay off your credit card debt in full at the end of each month, but sometimes it simply isn’t possible.
There might be other more expensive debts that need clearing first, or simply the debt has gotten out of control and you don’t have the cash to clear it all in one go.
In order to work out if it’s cheaper to try to increase your repayments each month (instead of paying the credit card minimum payments) or getting a balance transfer credit card, you will need to assess how long it will take you to clear the debt and how much interest you will end up paying over that time.
If the transfer fee is less than the interest you’d pay and the deal is long enough to clear it within the same time, then you know a balance transfer credit card is a better deal for you.
Ultimately, where possible, always avoid just paying the credit card minimum payment. Increasing your repayments is always going to be a cheaper way of clearing your debts.
Remember, you will have to have a good credit rating in order to get a balance transfer credit card so be sure your financial history is in good order before applying.
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