A credit card is not more than a small piece of plastic but it has the power to transform your life. It is the key to a better lifestyle and higher standard of living albeit at a cost. You can spend more than you earn and keep paying off the amount with the passage of time. All in all, it seems like the best possible deal you would find. But this is not the case.
Credit cards are one of the main reasons why the recession got stronger and stronger and is still not showing any signs of leaving. They are also the source of a majority of the debts faced by working class people. Yet, people still don’t mind swiping the credit card when it comes to making a purchase even in the face of debt settlement. This is because of a weird thing known as the minimum payment.
The Minimum Payment Conundrum
The minimum payment conundrum is complex and confusing. As per definition, it is the least possible amount a person could pay to continue using the credit card. The minimum payment is less than the total amount owed yet enough for the credit card companies to be certain that they are not being swindled.
The problem with minimum payment is, well, it is a minimum payment. This means that if the person is unable to make further payments for whatever reason, they would be left with a large chunk of the debt. However, this does not mean that you should stop using credit cards. In fact, minimum payment is an incentive for using your credit card. First, let’s go over how the minimum payment is calculated.
How Credit Card Companies Calculate Your Minimum Payment
There are three factors considered by the companies when they calculate your minimum payment.
- Your average daily balance is the amount of money you spend on the credit card each day. At the end of month, the daily amounts are added up to reach a final figure. The amount is then divided by the number of days covered in the payment period.
- The next step is translating your Annual Percentage Rate (APR) on to a monthly basis. This means you have to divide the rate by 12 which will give you the monthly rate of interest. This number is then multiplied to the figure calculated in the first step.
- The monthly interest calculated in the second step is then added to the monthly balance you calculated in the first step. Then the figure that comes is multiplied by the minimum payment rate. The rate is different for most credit card companies but is usually within the 3-5% range. The minimum amount rate is then multiplied to the sum of your monthly interest and balance. This gives the company your minimum monthly payment.
These are the three steps followed by credit card companies to calculate your minimum payment.
Why Minimum Payment Is Less Risky?
The intention of credit card companies when deciding the minimum payment rule was to ease the burden on their customers. The consumers don’t have to pay a high amount every month just to service their debts. It only makes it difficult for them to deal with their day to day expenses and takes a large chunk out of the family budget.
The element of risk is low when making minimum payments because of a couple of factors. Firstly, you don’t have to pay the entire amount you owe to your credit card company. This means that you have sufficient cash left over to deal with the other expenses you owe. You don’t have to delay paying your utility bills or house rent because of the credit card payment.
This means that the only debt you are going to have at the end of the day is your credit card debt. And that too is covered by a limit beyond which you cannot spend. Worse comes to worst, you will be left with your credit card debt in case anything goes wrong but the amount is not as high as it would if you had obtained a loan or a mortgage. Debt settlement is easier when you don’t have to pay a high amount.