Paying Minimum Amount Due in Credit Card Statement is not enough

You have been struggling with cash flows off late. Full-EMI for your home loan started two months back. You had to help a family member during a medical emergency in the last month. You had to purchase an expensive gift for a friend’s wedding.

You realize there have been too many unplanned expenses in the past few months. For many of those, you have had to swipe your credit card.

You received your credit card statement yesterday. It was nothing less than a shock. You have to pay Rs 50,000 within next 2 weeks. You are aware of the almost usurious interest rates that banks charge on credit card debt. You want to avoid paying such high interest at any cost. Given your finances at the moment, you fear you might slip into a debt trap. Your attention goes to an item in your credit card statement, Minimum Amount Due, which happens to be a very small amount, only Rs 750.  This amount, you can easily manage.

You are wondering if you can tide over the problem by paying this minimum amount due. What are the implications? Does paying Minimum Amount Due mean that you avoid paying high interest rate?

Let’s find out.

What is Minimum Amount Due? How is it calculated?

Minimum Amount Due or Minimum Payment Due is typically 5% of the total outstanding amount in your credit card statement.  There are minor changes in the following cases.

1. If you have opted for any EMI on your credit card (balance transfer or converted purchase into EMI), then such EMIs will also be added to Minimum Amount Due.
2. Any unpaid Minimum amount from your previous statements will also be added to the current statement.

Let’s understand this with the help of an illustration.

1. Credit card statement date is 5^th of every month
2. You have to pay the bill by 26^th of every month
3. Late payment fee is Rs 500
4. Interest charged at 3% per month

 

December Statement

You have been paying your bill in full till such time. Hence, there are no additional charges in the bill. Minimum Amount due is 5% of the bill amount i.e. 5% * 20,000 = Rs 1,000

January Statement

You paid only the Minimum Amount Due. Hence, interest free period that you got for purchase made on November 15 is revoked. You pay interest from the date of purchase i.e. November 15.

For the new purchases made in the month of December, there is no interest free credit period. You are charged interest from the date of purchase.

Late payment fee was not charged in January statement since you had paid the Minimum Amount Due.

February Statement

You did not even make the Minimum Payment Due from the January statement. Hence, you have been charged late payment fee.

Notice the calculation of Minimum Amount Due for February statement. Since you did not make even the minimum payment for January statement, minimum payment for January statement has been added to Minimum Payment Due for February.

Benefit of interest free credit period gets revoked if you do not make the credit card payment in full. You can get up to 52 days of interest free credit period if you make credit card payment in full.

Service tax is charged on both late payment fee and the interest amount.

How does paying Minimum Amount Due help?

If you do not pay even the Minimum Amount Due, the bank will report your account as irregular to credit bureaus such as CIBIL. If your account is reported irregular to CIBL, your credit score will be adversely affected. A low score credit score will hurt your ability to get loans from banks and financial institutions.

Additionally, the bank may not charge you any late payment fee if you pay Minimum Amount Due.
This is also evident from the illustration.

By paying the Minimum Amount Due, you manage to keep your account regular and avoid any late payment fee.

Where paying Minimum Amount Due does not help?

Do note you are still charged interest on the unpaid amount. If you thought you could avoid high interest rate by paying Minimum Amount Due, you were wrong.

And the method of calculation of interest might surprise you.

As you can see in the illustration, the interest is charged not from the due date but from the date of purchase. You made a purchase on November 15. Since you had been making full payments till then, interest was not charged in statement on December 5.

You did not make full payment in December (and paid only Minimum Amount Due). Hence, in January Statement, your interest free period for purchases was revoked and you were charged interest from the date of purchase i.e. November 15 or December 25 as the case may be.

You lose out on interest free credit period if you pay only Minimum Amount Due.

Typically, you can get interest free credit up to 52 days for purchases made on credit card.

If you keep paying only the Minimum Amount Due

How long will it take to settle the credit card debt if you keep paying only the Minimum Amount Due?  Let’s suppose Minimum Amount Due is higher of Rs 500 or 5% of outstanding amount.

If you make a purchase of Rs 20,000 and no further purchase on a credit card during your life and just keep paying minimum amount due, it will take you 77 months to pay the debt in full.

You will pay a total of Rs 48,876 over purchase of Rs 20,000. That is too much. This is an interest of 42% per annum.

If you had spent Rs 2 lacs, it would take 214 months (almost 18 years) to pay the debt in full. You will pay Rs 6.06 lacs in total for a purchase of Rs 2 lacs. Again interest rate of 42% per annum.

You can see paying Minimum Amount Due is not really taking you anywhere.  You can think about doing it for a month or two but not more than that. Interest cost on credit card debt is too high. You must explore other ways to bring down the cost of debt.

PersonalFinancePlan Take

1. Make your credit card payments in full.
2. Try not to get into such a situation where you have to even think about paying only Minimum Amount Due. Borrow/spend only as much as you can easily repay.
3. Paying the minimum due can be used to tide over short term cash flow mismatch, say for a month or two. It is not a long term solution.
4. Minimum payment only preserves your credit history and avoids late payment fee. High interest rate is still charged on the unpaid amount.
5. If you are struggling with credit card debt, explore ways to bring down interest cost. Talk to friends and family for short term help. Try to avail cheaper personal loans to square off credit card debt. Credit card balance transfer can also be an option.
6. Manage the situation proactively and aggressively. Control your expenses. Given the high rate of interest on credit card debt, you may get into a debt trap sooner than you think.

Credit: This post is based on a guest post I wrote for EMICalculator. You can read that post here.

Image Credit: The original image and information about usage rights can be downloaded from Pixabay