How do credit card companies figure the minimum monthly payment?

Minimum monthly payments may seem arbitrary at times, but rest assured, they are precisely chosen by the credit card company. How can you begin to understand the process of how credit card companies determine minimum monthly payments?

Traditionally, the minimum monthly payment is based on a consumer’s total loan amount or balance. Typically, it is not actually based on a particular rate like the interest rate. Instead, it is based on the continuing balance and usually accounts for roughly 2% of the total.

You will notice both the account balance and the minimum payment due are printed on your monthly statement. Here is an easy way to figure out the traditional monthly minimum percentage: simply divide the minimum payment by the total balance. For example, if you have an account balance of one thousand dollars and were making a minimum monthly payment of $20 a month, you could easily ascertain that you had a minimum monthly percentage of 2%.

Other Factors Involved in Determining the Figure

However, there are other factors involved in calculating the total. First, the outstanding credit card balance is taken into account. This is also called the previous balance, or the amount carried over from last month. The APR or Annual Percentage Rate is the next factor to consider. The APR amount is stated on the credit card statement, as well as in the terms and conditions of your contract.

Simply put, APR is the entire interest rate for a whole year as opposed to just a monthly rate. When you read the term “nominal APR” this refers to the simple interest rate for a year’s time. “Effective APR” goes one step further and includes the fee plus the compound interest rate for a year’s time. Besides APR, you will also be paying for transaction fees, which are fees charged every time you carry a balance. (They can range from half a dollar to over $4.00).

In past times, credit card companies literally used the default of 2% to calculate minimum interest. However, over time they started adjusting the formula to include finance charges and extra fees. Therefore, what was once a 2% of total balance minimum payment due, eventually became a 1% of total balance but plus other fees and interest, thereby bringing the total to an amount near 2%.

Blink and you miss the point:

By paying more in finance charges and fees (even if it equals the same minimum payment more or less) and limiting yourself to 1% of the balance, then you are actually increasing the length of your loan. This is not even considering other fees the company might tack on such as over-limit fees, late fees, processing fees and insurance fees, all of which can appear on the final bill. Chances are that the average consumer never notices this!

Will New Government Programs Really Help?

Today, credit card companies differ in their approach to setting the minimum payment due. Some may still use the default percentage rate of 2-4% while others have adopted the sneakier 1% plus fees galore strategy. It should be noted that in the year 2003, the government branch called the Office of the Comptroller strongly recommended that credit card companies adjust their minimum monthly payment formula for the benefit of consumers.

Credit card providers were asked to alter the minimum due so that customers could pay a larger portion of their balance, making more of a payment on the actual debt. The new formula was the APR rate plus the transaction fees multiplied by the balance and then plus one percent of the outstanding balance. This formula allowed customers to pay more money on the actual debt and minimize some of the interest and extra fees that were, in essence, holding the account in a stalemate.

Some of the top credit card issuers like Bank of America, Wells Fargo and Citibank have followed the Office of the Comptroller in their advice and have altered the minimum payment due according to this formula. Remember also that some companies may give you the option of paying the formula figure or simply paying 2% of the total balance.

Beware of the Minimum Payment Temptation

The ultimate flaw of paying only the minimum monthly payment is that you’re really only paying for predominately interest and for the right to keep the debt active. Sounds crazy doesn’t it? You are paying them for the right to stay in debt to them!

Little of your actual payment will be paid on principal if you continue making the bare minimum. A better strategy for getting out of debt is to pay at least twice of the minimum monthly payment. The more you pay towards the principal, the less overall finance charges you will pay.

Start taking action to pay off your debt faster. Pay attention to your credit card statement and then ask your credit card company how they figure the minimum monthly payment. If you feel that you are paying too much interest then consider the option of refinancing. Remember that over time, minimum monthly payments can rise with accumulating interest and balance.

It’s best to take care of rising debt now rather than wait until the situation becomes critical. If you are suffering in debt then try contacting a debt consolidation company and requesting help. If you are searching for a new credit card then utilize our free credit card “Chaser” tool to help you discover the best options. Get started “chasing” down the best credit cards today!