The Hidden Danger of Minimum Monthly Payments
The prospect of a low monthly minimum payment on a credit card or loan is enticing, especially if you don’t know the true, long-term cost.
First, you need to understand how interest accrues. If you have a loan with an interest rate of 15 percent APR, that means you’ll be charged 15 percent of the total loan each year. So if you have a $5,000 loan, you would pay 15 percent of that in yearly interest for a total of $750.
Now, let’s say your creditor sets your minimum monthly payment at $70 to eventually pay off that loan. If you made that minimum monthly payment of $70 every single month for a year, you’d pay $840 ($70 x 12 = $840).
And $750 of that would go to just interest.
That leaves only $90 that you paid toward the principle, the original $5,000. At this rate, it would take 15 years for you to pay off the loan, and you’d end up paying a total of $12,600 — $7,600 more than what you borrowed! Not a wise financial move.
With that same scenario — $5,000 debt with 15 percent APR — but paying $100 each month instead of $70, you’d pay off the loan in about 6.5 years and pay a total of roughly $7,900. Bump the monthly payment up to $125, and you’d pay it back in 4.5 years for under $7,000.
Recap for $5,000 debt at 15% APR:
- $70/month payment = 15 years of payments = $12,600 total
- $100/month payment = 6.5 years of payments = $7,900 total
- $125/month payment = 4.5 years of payments = $6,906 total
A minimum monthly payment can be very misleading. It does not show you how much you eventually pay in interest fees. But with a little math, you can quickly see that in this example an additional $30 per month made a difference of more than 10 years and almost $5,000 in interest payments.
If your personal spending plan (i.e. budget) allows for it, it’s always better to pay off any debt early through larger monthly payments.