Credit cards companies offer what initially seems like a benefit, but over time can become a trap. They offer high credit limits with low monthly payments. The minimum payments generally range from 2.5% to 3% of the average monthly balance. This feature allows you to run up very high credit card debt, while still paying low monthly amounts to keep the debt current.
The trouble comes when the debt continues to rise and the monthly minimum payments are all you can make. Credit card companies frequently have high interest rates generally ranging from 15% to 30%. At these rates, making only minimum payments will result in 25 to 30 years of payments and the total balance paid, 2 to 3 times the original amount charged.
Minimum payments needed to keep the debt current are small compared to the balances. Yet, as your balances reach the credit card limit your credit score declines. A lower credit score could result in the credit card company lowering your credit limit and/or raising the rate, making it harder to pay off the debt.
Credit scores are impacted by several factors. Your utilization ratio is a key factor in determining your credit score, accounting for 30% in the calculation. Utilization ratio takes your credit card balances and divides them by your limits. The higher the ratio, the lower your score. Customers with good credit keep balances lower than 50% and those with great credit keep the ratio below 30%, or pay their balances in full every month. Paying bills on time accounts for 35% of your score. As you can see, utilization is scored almost as high as payment history.
Here is an example. If you have $45,000 in credit card debt, at 16.99% interest, with a minimum payment of 2.5%, it will take 29 years to pay off the debt. The total interest will be $57,125 added to the original purchases of $45,000, making the total payments $102,125. The minimum monthly payment on the $45,000 balance is over $1,100 a month. If you are able to make minimum payments on your debt, then this offers a short term solution. Review your budget and find ways to reduce spending. Make minimum payments on all your credit cards except one. On that card (most often the one with the highest interest rate) pay as much extra as possible. Do this each month until the first card is paid off. Then add that payment to the next card until it is paid off. This strategy will take a long time, but will eventually pay off your debt.
When using any debt reduction strategy you must stop charging. Adding new debt each month, as you pay debt off, will result in little or no real progress. Living under your means is essential for success.