How do minimum credit card payments work?

If you have a significant balance on your credit card, the idea of paying it off completely can feel daunting. You might be tempted to make just the minimum payment instead as a way to avoid additional penalties, but this strategy, along with unexpected emergencies, can quickly lead to a mountain of debt that ends up costing you hundreds of dollars extra in interest.

While making just the minimum payment on your credit card is an option, we don’t recommend it. And even paying just slightly more every month can help you save a whole lot. We breakdown the facts below.

What is a credit card minimum payment?

The minimum payment is the absolute least amount of money you must pay towards your credit card every month to maintain your account in good standing and ensure:

• You don’t get hit with additional late fees
• You don’t face an increase in your credit card’s annual interest rate
• You don’t get reported for making a late payment to credit bureaus, and
• You don’t lose any of the benefits or rewards offered by your credit card.

All that good stuff aside, however, you’ll still rack up hefty interest charges since you’re carrying a balance and paying off just a tiny fraction of what you owe. In fact, by making just minimum payments, you’ll set yourself up to owe more interest over a longer period of time.

You can find the minimum payment amount clearly labelled on your credit card statement and you’re required to pay it by the due date shown as part of every 30-day billing cycle. The minimum payment is usually a tiny percent of your credit card debt.

How are credit card minimum payments calculated?

Not every card issuer follows one standard formula.

In the majority of cases, card issuers will set your minimum payment as a percentage of your total balance – usually 2% – 3% or $10, whichever is greater. Under this logic, a balance of $4,000 would work out to around a minimum payment of $120 (3% of $4,000).

Some card issuers follow a slightly different formula whereby the minimum payment is determined as $10 plus any interest you racked up during the previous monthly billing cycle. For instance, if you owe a $4,000 balance on a card with an annual interest rate of 19.99%, your minimum payment would be $10 plus roughly $17 in interest charges for a total of $27.

In either scenario, one fact holds true: the more money you owe on your credit card, the larger your minimum payment will be.

What happens if I only make the minimum payment on my credit card?

While making just minimum payments every month will maintain your account in good standing, this strategy won’t help you pay off your balance quickly. Quite the opposite in fact, as it can result in years of payments with very little progress and a great deal of interest owed.

Here’s an example of how long it can take to pay off a credit card balance if you only make the minimum payment versus adding slightly more every month.

If you owe $5,000 on your credit card, the minimum payment would likely be around 3% of the balance – or $150 – though this amount will decrease as your balance becomes smaller.

If you only make the minimum payment on your credit card balance, it will take you 20 years and 11 months to clear it off in full, and during that time, you’ll pay $5,983.91 in interest – more than the original balance! But, if you add just $100 per month to that minimum payment, you’ll cut your time to debt freedom down to three years and two months and only pay $1,491.87. That’s almost 18 years and nearly $4,500 in interest saved.

The minimum payment trap

After seeing the table above, you may be wondering how paying just a few extra dozen dollars towards your credit card every month – on top of the minimum payment – can have such a huge impact. Well, that ties into what’s known as the minimum payment trap.

By paying just the bare minimum, a huge share of your money will go towards covering your interest charges for the month and not your principal (which is the original sum of money you’re borrowing). Hence why it’s a trap – minimum payments essentially force you into a cycle where you keep paying interest while also making it extremely difficult to clear the debt you owe in the first place.

While the best course of action is to always pay off your credit card bill completely to avoid owing any interest, if you’re not able to do so, paying extra on top of your minimum payment can go a long way in helping you overcome this trap.

If you’re curious about how credit card interest works and how much you can save on your credit card’s interest charges by making extra payments, the Government of Canada has a handy calculator to help you explore different scenarios.

How only making minimum payments affects your credit score

As long as you make your minimum payment on time every month, you’ll have what’s considered a positive payment history. That’s good news since payment history is the single largest factor that goes into formulating your credit score. Lenders want proof you can be trusted to make payments on time, and meeting your minimum payment obligations mostly ticks off that box.

That said, credit scores are multifaceted and making just minimum payments could have a negative side effect on your rating by impacting your credit utilization.

Credit utilization is a measure of how much debt you owe relative to your total credit limit. The more of your credit limit you use up, the higher your debt load, and the higher your credit utilization – which some lenders may take as a sign you’re overleveraged. The general rule of thumb is you should carry no more than 30% of your card’s limit as debt.

When you only make the minimum payment, you’re decreasing your credit card debt by an extremely small amount, keeping your credit utilization high and indirectly hurting your credit score. By paying over the minimum, you’ll be doing a whole lot more to decrease your debt and utilization ratio, and your credit score can benefit as a result.

Why you should pay more than the minimum payment each month

Sometimes making only the minimum payment on your credit card seems like the easy option, but it is important to know that this should not be a continued habit. If you can afford to pay more than the minimum, you might be surprised by the positive impact it can have on your credit card balance, interest payments, and much more. 

• Pay off debt quicker: While paying the minimum payment allows you to avoid late fees and additional penalties, you won't make progress in paying down your balance. By paying more than the minimum, you can drastically shorten the time it takes to clear your debt. See the example above for a quick refresher. 
• Reduce interest costs: When you pay only the minimum payment on your credit card, the interest charges continue to accrue on the remaining balance. This results in a higher overall interest cost over time. By paying more than the minimum each month, you can effectively reduce the principal balance owed on the credit card leading to lower interest charges. 
• Impact on your credit score: As your credit card balance increases, so does your credit utilization ratio which significantly affects your credit score. Higher credit card balances can negatively impact it over time. It is ideal to maintain a credit utilization ratio of less than 35% of your total combined credit limit, and where possible keeping it even lower than that will be better for your credit score. 

Healthy credit card usage tips

If you’re actively working to pay down your credit card balance, here are some tips to help you become debt-free sooner:

Use your credit card selectively – only charge new purchases to your credit card if you have the cash on hand to pay them off. In fact, you should consider putting a hold on your credit card spending and sticking to just debit or cold hard cash until your debt is cleared. If you’re low on options and need to borrow money through your credit card, be extremely cautious and limit your card use to paying for absolute necessities (like groceries and internet bills) while avoiding charging any large or otherwise discretionary purchases.

Choose a low interest credit card – a lower interest rate means you’ll pay less interest and more of your extra payments will go towards paying down your debt principal. Choose a low interest credit card, like the MBNA True Line Mastercard, which only charges 12.99% interest (not 19.99% like most cards) and has no annual fee.

Take advantage of balance transfer offers – Some credit cards offer extremely low interest on balance transfers for a limited period – usually around six to ten months. These balance transfer offers let you get a jump start on paying off your debt by allowing you to transfer your old credit card balances to a new card and pay a super-low interest rate. Note though, you’ll be required to make minimum payments and the interest rate will return to normal levels after the promotional period expires, so you’ll need to have the cash on hand to pay off as much of your balance within the promotional period as possible.

How to pay off credit card debt

If this blog (and the table above) has convinced you to get serious about paying off your credit card debt – great! Now it’s time to buckle down and start making extra payments. There are two primary strategies for debt repayment that are used widely by Canadians – especially those who are carrying multiple debts.

The snowball method

The snowball method is a debt reduction strategy popularized by Dave Ramsey. This strategy advocates that you order all your debts from smallest to largest balance and to use most of your money to pay off the smallest one first, regardless of the interest rate.

The strength of this strategy lies in the fact that it fully accounts for the “human element” of paying off debt. Psychologically, the snowball method sets you up for success by rewarding you early in your debt repayment journey with “quick wins” as you eliminate your smaller debts. As you pay off your smaller debts, you snowball those payments towards your larger debts, eventually tackling the biggest debt with full momentum.

If you’ve never paid off large amounts of debt before, or have tried in the past and lost enthusiasm, the snowball method could be a good option.

The avalanche method

The avalanche method is more mathematically sound because it calls for you to order your debts from highest to lowest interest rate. You’ll tackle the debt with the highest interest rate first, regardless of the balance. The debt with the highest interest rate is the most expensive to service, so tackling it first will result in you paying the least amount of interest possible, and will allow you to become debt-free the quickest.

The avalanche method usually calls for credit card debt to be paid off first, so if you’re eager to get your credit card balance down to zero, this strategy might be right for you.

The bottom line

Many Canadians make the minimum monthly payment on their credit card balance, resulting in it taking years and thousands of dollars in interest charges before their debt is paid off. This scenario is very common but also entirely avoidable. By making just a little more than the minimum monthly payment on your credit card balance, you can become debt-free in a matter of months, not years, and save thousands of dollars in the process.