One number everyone has to read on their credit card bill is the minimum amount due; it’s the answer to their month! At least the smallest amount that doesn’t incur a late fee and leaves the billing cycle unaffected is the minimum.
The minimum payment does the same thing for all of the millions of Americans with credit card debt, in that it serves as a monthly reset; they pay the minimum payment, and the account is current, but the financial situation is still manageable for a further month.
What that number doesn’t tell and the credit card statement doesn’t make clear is the price of paying just that much. No one is going to pay off the debt by making the minimum payment. The most costly means of transportation.
The mathematics that credit card statements obscure.
The minimum payment on credit cards is usually the higher of a fixed dollar amount (e.g., $25 or $35) or a small percentage (e.g., 1 percent to three percent, accruing interest plus fees). If a balance of $5,000 is owed and the interest rate is 22 percent a year, the required minimum monthly payment is about $100 on this amount.
The part of the statement that isn’t front and center is how long it will take to pay off the debt if you make just the minimum payment and what the total interest will be at that time. If you owe $5,000 on a credit card and you pay an average of 2 percent of the balance and you have a 22 percent interest rate, then you will be done with your credit card debt in about 29 years.
After that length of time, the total interest paid would be approximately $9,000, which is almost twice the original amount. The consumer who made $5,000 forfeiture to the card will have paid barely$14,000 to liquidate the card. It’s no doomsday situation. It’s the math result of the minimum payment structure on a balance and rate that are totally representative of American consumer credit card debt.
In addition, the Credit Card Accountability Responsibility and Disclosure Act of 2009 (CARD Act) dictated that credit card issuers have to display what the payoff period would be at minimum payments based on the average interest rate and the total of interest that would accrue over the time to payoff with minimum payments – assuming that at first this was done, a transparency measure that revealed shocking facts to many credit card holders.
Why the minimum payment trap is structurally engineered.
The minimum payment count is no coincidence. The formula for minimum payments is 1% to 3%, meaning that if one is using this formula, the principal paid decreases very slowly at the start of repayments, as high interest charges dominate the early years of a loan. With the amount of $5,000 at 22 percent interest per year, the monthly interest will amount to about $92.
If a minimum payment of $100 (2 percent of the balance) is made, the principal will only be reduced by the amount of $8. The main part of interest for the following month is slightly lower, as is also the minimum interest payment on the loan, which further prolongs the repayment period. The vicious circle of low minimums, slow principal going down, high interest going up, high minimums going up is one of the best that could be devised from an interest extraction standpoint in consumer affairs.
It represents an ongoing debt service for the borrower instead of debt retirement, representing a stream of interest income for the lender that has the potential of continuing for many years based on an event that may have been the purchase of a relatively small investment or the filling of a budget shortfall for one month.
Why educators are specifically vulnerable to the minimum payment cycle.
Several financial attributes of the educator population create greater sensitivity to the minimum payment trap in particular. Although teachers’ salaries have remained uniform, at the median household income (62,558) at the national level, according to the BLS, salary ranges from state to state. This salary does not provide a margin for paying for housing, transportation, food, and basic household expenses, with funds to dedicate to other debt obligations.
The minimum payment profile is the number you pay when you have so much credit card debt, whether because of one big expense, one short period in which you have less income than usual, or because of the slow creep of an extra chip over the previous years, that the minimum payment is virtually the only payment you’ve got. It’s the amount that fits. Any increase in payments would have to cut back on other payment commitments or spending categories, which might not be able to be compressed.
The issue is that the smallest payment made in a particular month doesn’t help to get the debt paid off. It extends it. Not only is the increase in monthly cost startling- it could be $50 or $100 more- but the interest charges add up over the years, and the amount stays outstanding.
What the consolidation calculation reveals.
It’s great to run the numbers, and really does help make the minimum payment question more tangible in the budget versus, say, lowering your interest rate and making fixed monthly payments to pay off your current debts. If the cost of keeping the minimum payment structure is spelled out up front, then it’s more of a financial choice, instead of a default.
A debt consolidation calculator will just do that – it will take the debt under current terms, the interest rate charged, the minimum payment schedule, and work out the cost of these debts till they’re down to zero, and it will show you what the exact effect of consolidating through a fixed-term, lower interest loan on those debts will be on the monthly payment and total interest deducted. If someone is carrying $12,000 in separate debt on three credit cards and the rate charged is averaging about 22 to 24 percent, the interest savings of a fixed-rate loan over 36 months could be several thousand dollars — and the peace of mind from knowing it will be paid off on schedule instead of paying small bits at an interest rate that feels impossible to keep high.
The psychological dimension that math doesn’t capture.
The interest calculations just don’t reflect the behavioral ramifications of paying several high-interest credit card balances: Cognitive burden from making several payments at once, several payments due at once, and having to keep several balances in your head all the time, plus the emotional burden of seeing that your debt is not meaningfully going down.
Financial stress is a constant brain drainer. Behavioral economics research has shown that financial fear impairs mental performance – thus taking up working memory that could be used for job tasks, problem solving, and more importantly, for financial planning over a period of time that strengthens over time. The financial burden of unpaid credit card debt is not a burden that is ‘somewhere else’ from that of educators who depend on their cognitive and emotional functioning for their job performance. Accompany them to the classroom.
When you combine multiple debts into one monthly payment with an end date, it isn’t just interest you are saving. It gets rid of a whole class of mental umbrellas, those flying under the radar, consuming bandwidth without any ringside seats, a kind of mental bandwidth that has no monetary return value but has a real value. See More