Minimum Repayments Don't get locked into debt, use credit card calculator

BEWARE, DANGER! Borrow �3,000 at age 21 and you'll be 50 before it clears! That's what happens if you just make minimum credit cards payments - their evil genius can lock you in perpetual debt, boosting banks' profits astronomically.

This full fightback plan includes the updated Minimum Repayment Calculator, which reveals, card by card, the huge cost and length of sticking to the minimum, plus how much you'll save by fixing the amount you pay.

Step-by-step guide

• Min repayments: Back to basics
• Why they're dangerous
• Step 1. A simple trick to beat the trap
• Step 2. Minimise the interest
• Step 3. Direct debit dilemma
• The exceptions to the rule

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Minimum Repayment Calculator

Minimum repayments: Back to basics

Unlike mortgages and loans, with credit cards you choose what you repay. The more you pay, the faster the debt disappears. The only restriction is the prescribed minimum repayment, the lowest amount you must repay each month to avoid a fine.

This isn't a fixed amount - it's usually a percentage of the balance. So the amount you repay each month will fall as your balance reduces, meaning it takes longer to clear. The longer you borrow for, the more interest you're charged as 20% APR means you're charged 20% of your outstanding debts EVERY year (see the Interest Rates Beginners' Guide).

In a nutshell...

The quicker you repay, the less it costs.

This means it's in companies' interests to set minimum payments low, keeping you in debt for longer, and repaying more to them.

How do rules affect me?

For all credit card applications since 1 April 2011, repayments must be at least 1% of the balance plus that month's interest, any default charges and the annual fee.

Although the rules technically only apply to new cardholders after 1 April 2011, many of the big card providers changed the minimum payment structure for all customers. The changes led to increases in monthly payments.

Click here for a run-down of when each provider applied the changes.

• American Express: Those who applied after 9 November 2010 have the new terms.
  
  
• Barclaycard: All cardholders have the new minimum repayment terms.
  
  
• Capital One: Those who applied after 1 July 2009 and "some other existing customers" have the new minimum repayment terms.
  
  
• HBOS/Lloyds: HBOS customers who applied after November 2010 and Lloyds customers who applied after January 2011 have the new minimum repayment terms.
  
  
• HSBC: Cardholders who applied from 23 March 2011 have the new minimum repayment terms.
  
  
• MBNA/Virgin: All card holders have the new minimum repayment terms.
  
  
• RBS/NatWest: Cardholders who applied after January 2011 have the new minimum repayment terms.
  
  
• Santander: All card holders will have the new minimum repayment terms.
  
  

Why are they dangerous?

Borrowers' aims are - or at least should be - diametrically opposed to that of credit card companies. We need to repay debt as quickly and cheaply as possible, they want to keep us perpetually repaying our debt and earning them interest. Minimum repayments are designed to do just that. Crucially, as the minimum is a percentage of your outstanding debt, then...

As your debt decreases, so does the amount you repay.

Minimum repayments must at least cover the interest, so your balance will fall each month (this wasn't the case before April 2011). However, as the minimum repayment amount is based on your balance, then as it decreases, so will your repayments. This means your debts will last for longer than if you were to make fixed repayments.

All of this has some startling consequences when you work out the numbers.

The Example: Mr John Shortovcash

Let's take a look at Mr John Shortovcash's debts.

• Credit card interest rate: 17.9% (pretty standard).
• Outstanding balance: �3,000.
• Minimum payment: The higher of 1% plus interest or �5.

Sadly, John's strapped for cash and and opts for the minimum repayment, so the amount he repays reduces each month. As the table below shows, at first there's not much difference; at the start he pays �71.50, then a month later it's �70.75.

Yet after a year he's only repaying �63, and soon the repayments plummet - meaning the debt lasts and lasts and lasts.

The impact is huge!

As John's paying less each month, the balance is reducing more slowly over time, while the interest costs continue to mount up.

Even if John never spent on the card again, and just made the minimum repayments, it would take him 27 years and 4 months to pay off, and cost �4,000 in interest!

The Minimum Repayment Calculator

This special minimum repayment calculator reveals how long your card will take to repay if you just pay the minimum. All the info you need should be on your credit card statement.

For the killer touch, you can compare the cost to a scenario where you pay off a fixed amount rather than the ever-reducing minimum. If John Shortovcash had done that, he'd have saved over �2,400 and repaid the debt 22 years sooner!

The easy three-step solution

There are two main reasons most people make just the minimum repayments. The first is because they simply don't know how damaging it is. If that's you, just increase the amount you repay immediately and the problem's solved.

Yet many simply cannot afford to pay any more than the minimum. Hopefully the rest of this site will help you through that - crucially, do a proper budget (see MSE Budget Planner). Yet even if you don't, there are still some easy steps to help resolve the problem.

• Simple trick to beat the min repayment trap

  There's a remarkably easy and powerful solution to all this. The minimum repayment trap is based on the fact that the more debt you've repaid, the lower your repayments go.
  
  So to stop that, simply make a fixed repayment based on what you can afford, rather than allowing the repayment to decrease each month.

An example helps it make sense...

Going back to John Shortovcash above, with his �3,000 debt at 17.9% interest, with minimum repayments of 1% plus interest. In the first month his minimum repayment was �71. If instead of just paying the minimum, he repaid this �71 every month, the scenario would change radically.

Making minimum repayments, it'd take him 27 years to pay off the debts and cost �4,000 in interest. But by repaying a fixed �71, he'd clear the debt in just five years and the interest cost would be �1,500; a saving of over �2,400.

Of course, if he could afford to pay even more each month, he'd be even better off.

Of course, this assumes John doesn't do any more borrowing. A good thing as anyone in debt, only able to afford the minimum repayments, needs to drastically cut back on spending and avoid all new borrowing.

• Reduce the interest you pay

  If you're paying a high rate of interest each month, your money is being eaten up by the card companies. If you paid less interest, you'd have more to throw at the balance.
  
  You can minimise the interest by doing a balance transfer; this means you can shift debts to another card at hopefully a cheaper rate of interest.

  You'll need a good credit history to do this (ie, you haven't been turned down for cards recently) - see the Best Balance Transfers guide for all the best buys.

• Direct debit dilemma

  Always set up a direct debit to automatically repay credit cards. This means you'll never be fined for missing or making a late payment. Yet on direct debit forms, the minimum repayment option looms large as it's by far the most profitable for lenders.

  Instead, if you can, set your direct debit at a fixed amount. Historically, lenders were bad at this, but the Lending Code's been revamped to force them to give you more repayment options.

  If it's still a struggle, write it on your direct debit form anyway and then call up to confirm it's done; the credit card company should honour it.

  Those who really can't guarantee repaying more than the minimum every month shouldn't panic.
  
  Just set up the minimum repayment by direct debit. But remember there's nothing stopping you making other payments on top, by cheque or from your bank account.

  The real danger is getting into the mindset of thinking �I'm paying my bill� just because you're repaying the minimum. Always try to pay more off whenever you can.

The exceptions to the rule

Having driven the fear of living hell into you with the above, you may be a little surprised to read there are times when making only the minimum repayments are good.

• When you�ve other, more expensive, debts
  
  A golden rule of repaying debt is to always put as much cash as you can towards repaying the debts which are at the highest rate of interest. This means you should make only the minimum repayments on all others. That way you get rid of the most expensive debts first, and then focus on the next most expensive (see the Credit Card Shuffle guide for more).
• To ensure you don�t get a credit card charge
  
  If you�re the type of person who may miss a payment or are late, not only will they fine you �12 a time, it is a HUGE smack to your credit rating; plus you can lose any cheap 0% or other deal you have.
  
  Therefore to ensure you never again miss a payment, set up a monthly drect debit even if only to pay the minimum. This may surprise you after all we�ve said. Yet here, it�s a defensive strategy to avoid missing the deadlines (if you�ve had past fines, read the Credit Card Charge Reclaiming guide).
  
  Yet setting up this payment ISN�T the same as me saying "only pay the minimum". This is a strategic move to not get a fine. When you get your statement, there is nothing to stop you paying as much as you can on top of that via web, phone or cheque to clear your debts.
• To stooze
  
  For the extremely financially savvy who are manipulating the credit card system to make free cash, then paying just the minimum repayments is the right move.
  
  Here if you're borrowing at 0%, and are earning money on cash lent to you elsewhere, the idea (contrary to all other times) is to maximise your borrowing.
  
  Though let me stress, this is only for those who know exactly what they're doing, and this has got much harder to do in recent years (read Stoozing: Free Cash).