Minimum Repayments – Avoid Unless Necessary

Forty-nine point three billion dollars – $49 300 000 000. That whopping number is how much credit card debt is held by Australians (as of May, 2011). How much do you owe?

The trouble with that number is not its size, nor is it the dollar amount that is represented for each credit card (which, incidentally, is $3321 per card, on average). The trouble with that number is that it is growing when it should be shrinking. The explanation for such growth is plain and simple – folks aren’t paying off their debts.

We all like to think we’re paying off our credit cards when we put down a little money each month. But more often than not, we get stuck financially and end up paying only the minimum. Sure, from time to time this is to be expected; we don’t always have any cash on the side, let alone extra money to repay our full credit card balance.

Unless you want to be stuck paying off the same debt for what seems like forever, paying only the minimum repayment should be reserved for the most desperate of times.

An Interesting Scenario

A few years back, one particular bank (which will not be named) became infamous for their minimum repayments, which actually didn’t allow you to progress in your repayment at all. The repayment amount was set so low, that interest was actually accumulating faster than the amount of repayment. After unfair conduct was argued, new regulations were implemented to limit how low providers can set their minimum repayments.

Are Minimum Repayments Much Better Today?

While current regulations dictate that minimum repayments must actually result in some amount of a credit card’s balance being paid down, paying the minimum can still keep you in a hopeless cycle of debt.

Here’s a hypothetical example for you (make note that interest rates change over time and vary by institution, so any numbers quoted here are purely fictional, but based as close to reality as possible).

Darrel has a credit card balance of $1000 with an interest rate of 15%. For the sake of this example, let’s assume that his rate is fixed for the life of his card.

Not really focusing or realising the consequences of his actions, Darrel decides to undertake the minimum repayments. After all, $1000 isn’t a lot of money, so paying it off doesn’t need to be a huge priority.

Darrel is stoked that his minimum repayments work out to only $30 a month. So he happily pays his $30 every month…for about 8 years and 7 months!

After 8 years and 7 months, Darrel has finally repaid his $1000 balance, along with a good $519 in interest.

Would this really happen?

While it’s very unlikely any reasonable person would spend almost 9 years making minimum repayments on a $1000 balance, this example gives a solid impression of how much unnecessary interest and prolonged debt you can get yourself into.

However, the other unlikely aspect of this scenario is that someone would repay their credit card and never use it again during the repayment. The sad reality is that many people will diligently pay down a credit card balance, only to rack it up to capacity when the next big thing happens.

How can I avoid this credit trap?

First, be wise about taking on credit. The ballooning number in Australian debt indicates that far too many people are taking on credit card debt while too few are actually repaying it. Ask yourself, can I realistically manage this debt and pay it off?

Second, be sparing in your use of credit cards. People these days tend to think they need a lot more than they do. For example, you can’t possibly live without new furniture for another day, so you need to put it on credit. Ask yourself, is this a situation where I have no choice but to put the purchase on credit (ie., vehicle repairs) or is it something I should save toward instead?

Third, be intentional about making balance repayment your number one priority. It’s when we put it off month after month that we get stuck in the endless cycle of debt. Instead of spending high on groceries and paying minimums, try paying extra on the balance of your credit card and scrimping at the supermarket. Ask yourself, are my spending habits keeping me trapped in an endless cycle of minimum repayments?

Minimum repayments should never be used as a ‘long term strategy’ for repaying your balances. They should be reserved for times when your budget is tight and has no room to spare, such as when more pressing or expensive debts must take priority.

If you are already caught in this nasty trap, consider a strategy such as repaying either your ‘Highest Interest’ or ‘Lowest Balance’ cards first, and ‘snowballing’ from there. Our credit card calculator will help you compare different repayment strategies.

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