Credit Cards: Why paying only the minimum credit due could hurt your financial health

Do you feel happy when you only pay the minimum amount on your credit card bill because ultimately, you have more money left to spend on other things. Also, you don’t have to pay any late fees or penalties.

But this happiness is temporary, as doing this consistently each month can put you in a bad financial position due to accumulating debt and rising interest obligations.

Let’s dive deep into this today.

But first, how do credit cards work?

When you use a credit card, you borrow money from a bank to pay for your bills. At the end of each month, the bank asks you to pay back the money you used throughout the month.

But generally, banks give you two options— either pay in full or only the minimum amount, which is a small part of the overall amount.

Now if you choose to pay only the minimum amount once in a blue moon, it’s not a matter of concern. But if you do it consistently for months, you could land into some serious financial crises.

Suppose you pay only the minimum amount each month, you will not be liable to pay any late fees or penalty. But the amount due every month will start to accumulate and will begin attracting interest charges.

You probably will not realise how small amounts each month will accumulate into a huge debt burden. It will attract more interest charges than the actual amount. That’s called the snowball effect.

Let’s understand it better with an example.

Imagine your credit card balance is   ₹50,000 with an annual interest rate of 24%. The minimum payment might only be ₹2000. If you continue to pay only the minimum amount, you still owe ₹48,000 to the bank.

The bank will charge interest on the remaining amount which might make it harder for you to pay even the principal amount.

Click here to know how the interest rate is calculated on the credit card.

How can paying only the minimum amount affect your credit score?

A credit score is a score ranging from 300 to 900 that represents the creditworthiness of a person. It shows how well a person is able to repay his debt obligations and manage his finances. If you consistently make timely payments, never miss an EMI, and follow good financial habits, your credit score will be closer to 900.

The reverse is also true.

If you only pay the minimum amount due each month, it is going to impact your credit score negatively. It shows lenders your inability to manage finances or pay your dues. In short, your creditworthiness is at stake when your credit score is low.

Minimum payments and the snowball effect

Let’s learn how paying only the minimum amount every month can land you in financial problems. Suppose you pay only the minimum amount for the first month and manage to avoid a late fee. But then, you continue to do it for the second month, then for the third month, and so on.

Before you will realise it, your debt will accumulate and it will go out of your control. Just like a snowball rolling down a hill and getting bigger, your debt will accumulate and attract interest.

How to manage it?

Here are a few ways you manage credit card debt and avoid snowball effect:

• Pay more than the minimum amount: Try to pay more than the minimum amount, even if it is a small amount. It will reduce your accumulated debt and avoid high interest charges.
• Create a budget: Create a realistic budget for yourself and identify areas where you can cut unnecessary expenses. It can be as easy as less dining out or avoiding shopping for branded clothes.
• Set small targets: Set small, challenging yet achieving financial targets for yourself. For example, paying high-interest debt first or prior to others.
• Avoid new purchases: Avoid new purchases through credit cards when you are already struggling to pay your dues. Instead, use your savings account so that your debt burden doesn’t accumulate further.
• Track progress: Regularly monitor your performance and debt obligations to get an idea of where you stand financially. Make necessary adjustments if needed, or take expert help when things do not go as you planned.

Final words

Just like when you start a SIP and your investments accumulate, creating a snowball effect, your debt can also accumulate if not paid over time. Moreover, it will attract interest penalties more than what your actual debt amount is.

By bringing some small changes in your financial habits, like avoiding using credit cards for every single payment, you can improve your financial position significantly.

Consult a financial advisor and seek help to improve your financial health when needed.

Padmaja Choudhury is a freelance financial content writer. You can reach out to her at [email protected].