Relying solely on minimum payments may seem convenient, but it’s a slippery slope that can significantly damage your credit score and creditworthiness. Making the minimum payments month after month will increase your credit utilization ratio due to carrying most of your credit card balances, which might reduce your credit score. In this article, we’ll dive deep into the impact of paying only the minimum payments on your credit score and strategies to maintain clean credit and secure your financial future.
How does paying the minimum payments affect your credit
Paying just the minimum due may seem like an easy way out, especially when facing financial constraints. After all, it helps avoid late fees and keeps your account in good standing. However, it’s important to remember that paying only the minimum amount due keeps you in a debt cycle, with interest accruing on the remaining balance. This can increase your debt balance and hurt your credit score.
Your payment history and credit utilization ratio significantly affect your credit rating, accounting for 30% of your FICO score and 20% of your VantageScore. Paying the minimum means you carry most of your credit card balances month after month. This, in turn, keeps your credit utilization high and lowers your credit score.
Does making minimum payments affect your credit score?
When you only pay the minimum due on your credit card, it may seem like you’re meeting your financial obligations. However, this approach can negatively affect your credit score in several ways due to higher credit utilization and increased debt risk.
So, let’s evaluate how making minimum payments affects your credit score.
- Making minimum payments leads to higher credit utilization. Paying only the minimum due means you carry most of your credit card balance. This balance contributes to your credit utilization ratio, the debt you owe compared to your total available credit. The credit utilization ratio is a significant factor in determining your credit score; experts recommend keeping it below 30%. However, to have a more substantial impact on your credit score, keep your utilization ratio under 7%.
- Paying only the minimum payments signals financial hardship. Making only minimum payments month after month can also indicate to lenders that you may not have the financial means to pay off your debt. As you make minimum payments, accrued interest increases your balance, increasing your DTI ratio. An increase in debt ratio increases the risk of default.
Why is making minimum payments bad for credit?
Consistently making only the minimum payments on your credit card can hurt your credit score. While paying just the minimum amount due each month may be tempting, it can lead to long-term financial consequences that you may not have considered.
The following are the risks of making the minimum payment on your credit cards.
- Risk of debt accumulation. When you only pay the minimum due amount, you increase the chances of getting into too much debt due to the growing interest and principal balance.
- Risk of lowering your credit score. When you make minimum payments on your credit cards, your credit utilization increases due to carrying most of your balance. Having a higher credit utilization ratio will lower your credit score.
- Higher chances of missing a payment. When you only pay the minimum, you increase the chances of missing a payment due to the growing interest and principal balance. Your payment history affects 35% of your FICO score. So, paying the minimum leads to carrying most of your balance, increasing your credit card debt. Higher balances also mean that your minimum payments go higher over time due to the balance you carried and accrued compounding interests. This can lead to late payments on your credit reports. Late or delinquent payments can severely impact your overall credit score.
- Risk of debt cycle trap. Making just the minimum payments can lead to a cycle of debt. Credit card interest rates tend to be high, and by paying only the minimum, you are allowing interest charges to accumulate on the remaining balance. Over time, this can result in a significant debt that is difficult to repay.
- Risk of not meeting other financial obligations. You are not actively reducing your outstanding balance by making only minimum payments. This can make it challenging to achieve financial goals, such as paying off debt, saving for a car down payment, investing in your future, etc.
What are the benefits of making only the minimum payment?
While it’s important to highlight the potential downsides of making only minimum credit card payments, it’s worth considering that there may be some benefits to paying only the minimum amount due in certain circumstances.
One advantage is that it allows you to maintain a consistent payment history and avoid late fees or penalties. By making at least the minimum payment on time each month, you demonstrate responsible payment behavior to creditors, which can help you maintain a positive credit history. This is particularly beneficial when facing temporary financial challenges, such as unexpected expenses or decreased income.
The minimum payment can also free up cash for other immediate needs or financial obligations. If you’re facing a cash crunch or have other pressing financial priorities, making only the minimum payment may allow you to allocate funds elsewhere without completely neglecting your credit card payments.
It is a good strategy for paying off debt. If you use the debt avalanche method to pay off debt, making maximum payments on your credit cards while putting maximum payments on the card or load with the highest interest makes sense.
Practical tips to maintain your credit score
Keeping a clean credit history and maintaining a good credit score are essential in your personal finance strategies. Good credit allows you to qualify for loans at lower rates and business services, saving you money.
Here are tips for improving your credit score and maintaining a healthy credit history.
- Pay your bills on time. Late payments can have a significant impact on your credit score. Not only can you lose up to 180 points on your credit score, according to LendingTree, but a late payment will also stay on your credit report for up to seven years. Set reminders or automate your payments to avoid any potential slip-ups. Learn more about 13 negative items on your credit reports.
- Maintain a low credit utilization ratio. This ratio measures the amount of credit you use compared to your total credit limit. A high utilization ratio indicates potential financial strain and may negatively affect your credit score. Aim for a utilization ratio below 10% to minimize its impact on your credit score and to demonstrate responsible credit management.
- Clean up your credit reports. Regularly reviewing your credit reports is also essential in protecting your credit score. Check for any errors, inaccuracies, or signs of fraudulent activity. If you identify any discrepancies, report them immediately to the credit bureau to ensure they don’t impact your creditworthiness.
- Avoid opening too many new credit accounts at once. Each new credit application can result in a hard inquiry on your credit report, which can temporarily lower your credit score. Be intentional with your credit applications and only apply for accounts you genuinely need and qualify for.
- Maintain a mix of different types of credit accounts. Lenders like to see a healthy blend of revolving credit cards, personal lines of credit, and installment loans such as car loans, mortgages, student loans, etc. While having a good mixture of credit accounts is essential, it’s necessary only to take on the credit you can manage responsibly.
- Communicate with your lenders. Consider reaching out to your creditors if you’re facing financial hardships. Many creditors offer hardship programs to help you navigate challenging times without damaging your credit score. By proactively communicating with your creditors, you may be able to negotiate modified payment plans or reduced interest rates.
You might also like to know how to avoid foreclosure on a home.
Final words
Paying the minimum payments is a risky game that can jeopardize your credit score and financial future. When you make only the minimum payments, you carry higher balances on your credit cards. This, in turn, increases your credit utilization, which might lower your credit score. Additionally, carrying too many credit card balances leads to accumulating debt.
Paying the minimum payment can be beneficial when facing financial hardships as it allows you to maintain on-time payments. You might also need to pay the minimum payments on some of your loans when using the debt avalanche debt management strategy.
