Aug 20, 2021 ●12 min read
Here’s How Paying the Minimum Amount Due on Your Credit Card Affects Your Score!
As financial institutions across the breadth and span of India push for the inclusion of credit cards and personal loans, more Indians than ever before are predicted to be using a credit card as their primary form of payment and leverage an instant personal loan in a financial strain, in the near future.
If you are also thinking of getting a credit card or you are already a present owner of this financial instrument, one question which must have definitely pondered your mind is how will paying only the minimum amount due affect your credit score, and in today’s article we will answer exactly that. Without further ado, let’s get started.
One of the first and most important aspects we need to understand is the meaning of the term minimum amount due.
In simple terms, minimum amount due can be understood as a partial payment for the total outstanding amount in your credit card statement. It is a failsafe mechanism orchestrated by the financial institution issuing the credit card, such that if you are in a financial strain, you can at least pay the minimum amount due and pay the remaining balance when your situation improves.
Around the world, financial institutions use a standard formula to calculate the minimum amount due based on the total outstanding balance in your credit card statement. While the actual mathematical calculation might be difficult to comprehend, in most cases, the amount is arrived at by deriving 5% of the total amount due. To understand this better, let us take the help of an example.
For instance, let’s assume that the total outstanding amount for your credit card statement in the period of 10th August to 10th September, 2021 is ₹10,000. Thus, according to the formula shared above, your minimum payment should be 5% of ₹10,000 that is ₹500. As you can see, this amount is very small compared to the total amount due and thus the name. But what happens if you only pay the minimum amount due on your credit card?
The consequences of paying only the minimum amount due on your credit card are many, and two of the most significant ones are as shared below.
Decrease in Credit Score
One of the first and most challenging pitfalls of only paying the minimum amount due in your credit card is the reduction of your credit score.
Let us explain.
You see, all the major credit rating agencies in the world take into account four main parameters to accurately calculate your creditworthiness in the form of your credit score. These are:
● The number of loans you have taken in the past
●The total amount of credit you have utilized in the past
●The total number of late payments you have made
● The total number of timely payments you have made
Taking these into consideration, every individual is assigned a credit score on a scale of 900. Now, when you only pay the minimum amount due on your credit card, the outstanding balance gets automatically carried forward to the next billing cycle, which in the larger scheme of things contributes to the total credit you have utilized.
As you witnessed from the above pointers, the total amount of credit you have utilized is the second most important criteria credit rating agencies use to calculate your credit score, and thus as you are only paying the minimum amount due, your total credit utilization is steadily increasing, thereby substantially decreasing your overall credit score in the long run.
To simplify this further, let us look at an example.
Let’s assume that you have a credit score of 780, and the total credit limit assigned to you by your banking partner is ₹120,000 in a whole year, meaning ₹10,000 for every billing cycle. Now, since you are in a financial strain, you pay only the minimum amount due every month (which is ₹500), and the remaining amount is automatically carried forward to the next billing cycle. Now, over the course of two quarters, your outstanding balance has risen to ₹57,000, which is 47.5% of your yearly credit limit.
As you might know, in order to maintain a good credit score, a healthy practice to follow is to keep your overall utilization below 30%, however; as we indicated in the example above, it has already touched 47%, marking the way for a decrease of your credit score and your overall creditworthiness.
Thus, it can be safely concluded that only paying the minimum amount due on your credit card over the course of a few months will lead to a significant decrease in your credit score. While a one off instance might not have significant impact, a repeated occurrence will do more harm than good.
However, that is not all; only paying the minimum amount due on your credit card arrives with another negative consequences, which is
Increased Interest Payment
Credit cards around the world and especially in India, arrive with some of the highest interest rates, in the range of 35% to 40% per annum. As outlined in your credit card agreement, once you pay only the minimum amount due, your banking partner will charge you interest on the total outstanding amount every month till you make the full payment, and without even realizing this might become a hefty expenditure. To put this into perspective, let’s extend the example we elaborated earlier.
In this case, the total outstanding balance on your credit card is ₹9500 for every billing cycle, which, if unpaid by the end of the next billing cycle, will amass an interest amount of ₹277.08. Thus, at the end of the next billing cycle, you will need to pay ₹(9500 + 277.08 + 10,000) = ₹19,777.08.
When you are taking a credit card or an emergency personal loan, one of the first commitments you should make to yourself is to always pay the total outstanding balance for every statement. While this might sound regressive at first glance, however as we illustrated in this article, crafting a habit of only paying the minimum amount due on your credit card will burn a hole in your wallet, both literally and figuratively.