How does Credit Card Minimum Payment Work?

Jack Prenter, Founder of Dollarwise

A credit card minimum payment is the minimum amount of money you have to pay toward your credit card and keep your credit rating stable. The minimum amount is either a fixed amount (most commonly $10) or a percentage of your total balance (depending on what you have more of).

While such a payment strategy is viable in the short term or during financial emergencies, it is not a good long-term strategy for several reasons.

Understanding credit card minimum payments

Definition & purpose of minimum payments

In Canada, a credit card minimum payment is the smallest amount you’re required to pay towards your credit card balance each month. These are typically calculated as a percentage of your outstanding balance, often around 1-3% but may also include fees and interest charges, or are presented as a fixed amount.

The primary purpose of minimum payments is to ensure that cardholders meet their monthly obligations and avoid late fees or penalties. They offer flexibility, allowing individuals to manage short-term financial constraints or unexpected expenses without defaulting on their credit card payments entirely.

However, while minimum payments can provide temporary relief, they have a downside. Paying only the minimum can result in accruing more interest over time, extending the repayment period, and ultimately increasing the total cost of the debt. It’s like treading water - you stay afloat, but you're not making progress towards reaching the shore.

For instance, let's say you have a credit card balance of $1,000 with an 18% annual interest rate. Your minimum payment might be around $20. If you only pay the minimum, it could take years to pay off the debt, and you will pay several hundred dollars in interest alone.

While minimum payments offer short-term relief, consistently paying only this amount can lead to long-term financial challenges. To efficiently manage credit card debt, we advise paying more than the minimum whenever possible. By doing so, you reduce the interest accrued and accelerate the path to becoming debt-free.

Calculation of minimum payments

There are two primary ways of paying minimum payments:

Fixed amount

This amount is determined at the issuing bank’s discretion and may differ from bank to bank. In most cases, you’ll pay the fixed amount only if it’s higher than the percentage.

To give you an example - Imagine having a percentage minimum payment rate of 1% and a $10 fixed minimum payment amount. You have $500 on your credit card.

1% of 500 is $5 which means you’ll have to pay $10 as the minimum monthly payment.

Percentage

If the card issuer is a federally regulated financial institution, all percentage-based minimum payments will be the same for such card issuers. In most cases, the minimum percentages range from 1% to 3% (apart from Quebec residents whose rate is 4% and will increase by 0.5% annually, until reaching 5% in 2025).

You can find which minimum payment options and the amounts your card issuer offers by checking your cardholder agreement. Log into your account on your card issuer’s website and navigate to your agreement.

There’s one last thing to note - certain banks have an additional minimum payment option that is activated automatically. In case your overall balance is lower than the traditional minimum payment amount (fixed or percentage-based), they will charge you your entire balance.

The implications of making only minimum payments

Long-term financial impact

Minimum payments should always be something to lean on during difficult financial periods but not the leisurely loan repayment option that people inexperienced with finances think they are.

By sticking solely to minimum payments, you inadvertently extend the duration of your debt and escalate the overall interest costs.

Extended Debt Duration: While minimum payments temporarily fulfill your obligation, they significantly prolong the time it takes to pay off your outstanding balance. This results in more months or even years of being tied to that debt.

Increased Interest Costs: The longer you take to pay off your balance, the more interest accrues. Credit card companies calculate interest based on your outstanding balance, and by paying just the minimum, you allow interest charges to accumulate.

This, in turn, amplifies the total cost of the debt, leading you to pay substantially more over time than if you had paid more than the minimum.

To help visualize just how impactful and necessary avoiding constant minimum payments is, we’ve prepared a few examples with the help of the Government of Canada’s credit card payment calculator (which you can use to calculate your own rates to see the impact on your loan).

Example #1 (Quebec resident)

We’re starting off with $2,500 on our credit card and an 18% annual interest rate.

Based on this example, we would pay $674.36 more in interest if we make only minimum monthly payments compared to paying $100 each month. And, for only $10 more than the minimum, we will save $328.93 in interest.

The amount of time saved is also impressive. Thirty months (2.5 years) sooner to pay off the debt if we pay $10 more than the minimum each month, sixty-four months (5 years, 4 months) sooner if we pay a fixed $100 per month.

Example #2 (non-Quebec resident)

This time, we have $2,000 on our credit card and an interest rate of 15%, but, our minimum monthly percentage is also lower as we are not Quebec residents this time.

This example features a repayment period that’s longer than in example #1 but the savings (time and money) are greater.

With Option B (paying $20 more than the minimum each month) will save you $1,942.29 in interest and 193 months (16 years, 1 month) time-wise.

Option C (paying $100 fixed, far more than the minimum amount) is the most efficient, saving $2,473.66 and 240 months (20 years).

No matter what the situation looks like, it’s always a better idea to pay at least a small amount more than the credit card minimum payment so you don’t run into financial issues during loan repayment.

Credit score considerations

Consistently making only minimum payments might signal financial stress or an inability to manage debt efficiently. This pattern could negatively impact your credit score over time.

Credit utilization, a crucial factor in credit scoring, compares your credit card balances to your credit limits. High utilization resulting from carrying large balances due to minimum payments can negatively affect your overall credit score.

This may also spill over and impact the number of available housing options as banks won’t be eager to give you a commercial real estate loan.

When paying minimum is the only option

Sometimes, meeting only the minimum payment on your credit card is the only viable option due to financial constraints or unexpected expenses.

While this can offer temporary relief, it’s essential to strategize for a gradual shift towards paying more than the minimum to alleviate future financial strain.

Budgeting and Prioritization: Begin by reviewing your budget. Identify areas where you can potentially cut back or reallocate funds. Prioritize your spending to free up extra money for paying down your credit card balance.

Incremental Increases: Commit to increasing your payments gradually. Even a slight bump above the minimum, say an extra $10 or $20 per month, can expedite debt repayment and mitigate increased interest costs. Set a timeline for these incremental increases to make it more manageable.

Windfalls and Extra Funds: Whenever unexpected funds come your way—such as tax refunds, bonuses, or monetary gifts—consider allocating a portion towards your credit card payment.

Payment Consolidation or Transfer: Explore options for consolidating debt or transferring balances to a card with a lower interest rate or promotional period. This move can provide temporary relief and potentially reduce the interest accruing on your balance, making it easier to pay more than the minimum.

Seeking Assistance or Guidance: If you find yourself consistently struggling with minimum payments, seeking guidance from a financial advisor or credit counseling service could be beneficial. These professionals can offer tailored strategies and advice to help manage your debt more effectively.

Remember, the goal isn’t to make drastic changes overnight but rather to slowly shift away from relying solely on minimum payments.

Strategies to manage credit card minimum payments effectively

Consistently paying more than the minimum, utilizing balance transfer options wisely, and automating payments can contribute significantly to your financial stability and reduce the burden of credit card debt.

Pay More Than the Minimum Amount: Opting to pay more than the minimum due each month can have significant long-term benefits. By paying more, you reduce the outstanding balance faster, reducing the time it takes to pay off your debt.

Additionally, this approach minimizes the overall interest charges incurred. For instance, making bi-monthly payments, effectively splitting your monthly payment in half and paying it twice a month, can help reduce excess interest charges. This strategy decreases the average daily balance, resulting in less interest over time.

Utilize Balance Transfer Cards and Payment Plans: Consider leveraging balance transfer cards or promotional offers that come with lower or 0% interest rates for a specific period. Transferring balances from high-interest cards can help manage and reduce balances more effectively.

However, ensure you understand the terms and fees associated with balance transfers. Additionally, setting up payment plans, especially during promotional periods, can allow you to focus on paying off the debt more efficiently.

Leverage Credit Card Autopay: Enrolling in credit card autopay ensures timely payments without the risk of missing deadlines. By setting up automatic payments for at least the minimum amount due, you avoid late fees and potential negative impacts on your credit score.

While autopay covers the minimum, it’s advisable to manually pay more whenever possible to expedite your debt repayment.

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