Why you should ignore minimum payment requirements

The minimum payment listed on your credit card statement each month is not a suggested payment. But millions of consumers appear to be using that number as a guide when they pay their bill.

The result: People who can otherwise afford to pay more are instead saddling themselves with unnecessary interest debt.

Research suggests Americans are taking the “path of least resistance” when it comes to credit card payments, with 29% of cardholders regularly paying little more than they are required to each month.

“The minimum payment may be an especially powerful anchor because it signifies staying in good standing with the issuer and avoiding late fees,” write economists Jialan Wang and Benjamin Keys. “This feature may create the perception that the minimum is a suggested payment amount, as the most prominent amount besides the full balance featured on credit card statements and payment interfaces.”

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What a minimum payment looks like

Issuers weren’t always so lenient on cardholders.

In the 1970s, the typical minimum payment was about 5 percent of the outstanding balance. The minimum fell to as little as 2 percent earlier this century, and today is about 3 percent on average, according to Wang’s and Keys’ research. (In truth, issuers’ formulas for figuring minimum payments can be fairly complex.)

But 3 percent is a ridiculously low percentage.

Here’s why: On one of my recent credit card statements, I had a balance of $2,947.73. My minimum payment due was $35, or about 1.2 percent of my balance. Had I paid just the minimum – I didn’t – it would take me 11 years to pay off the balance.

During that time, I would have paid $5,551 in interest, or roughly double what I owed to begin with, my statement showed me. And that is only if I accumulated no other credit card debt.

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What the study showed

For their study, Wang, an assistant professor at The Wharton School at the University of Pennsylvania, and Keys, an assistant professor at the Harris School of Public Policy at the University of Chicago, examined credit card balances of a segment of card holders between 2008 and 2012.

This group held on average three general purpose credit cards – in other words, not store cards – with a total balance of $11,000. The typical cardholder had $66,000 in annual income and a 701 FICO score.

Neither age nor annual income can entirely explain whether someone paid significantly more than the minimum requirement, the study found. In fact, consumers earning more than $150,000 annually made near-minimum payments 38 percent of the time, while cardholders over 60 made low payments 38 percent of the time.

This does not represent a significant advantage over people who earn less or who are younger.

Credit scores do appear to correlate with larger payments. The study found that consumers with FICO scores below 700 made low payments about two-thirds of the time, while borrowers with scores above 800 paid the near-minimum just 18 percent of the time.

The study examined what happened when issuers raised minimum payments. During this time, minimum payments for affected borrowers rose roughly $18 or about 5 percent of the balance.

But here’s the funny thing: When issuers raised the minimum required payment, people with low balances paid more with little difficulty – by just enough — but people with higher balances ended up paying less than they had in the past.

This weird psychological collision suggests the number you see on you statement is counterproductive.

Ignore it.

Instead, we should work to pay off our balances as quickly as possible regardless of what the issuers tell us.

If you can’t pay off your balance every month – and if you can, but don’t, you should stop – you should figure out what you can reasonably afford to pay. Use our debt payoff calculator for your situation to make your decision easier.

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Mike Cetera

A savvy borrower always pays his debts. I'm a reporter at Bankrate, and I'll show you how.