Credit Cards guides

Avoid the Minimum Repayments Trap

Making the minimum repayment on debts might seem like it is costing you next-to-nothing each month, but in reality you might be paying a lot more back than you need to.

If you only make the minimum repayments on your credit card, one holiday could end up taking you twenty years to pay off. Minimum repayments, are the enemy. Well never fear. Our guide will tell you what minimum repayments are, how to avoid them and ultimately, how to save yourself thousands of pounds and years of debt. And all in a few easy steps.

What is a Minimum Repayment?

With other forms of lending, such as loans and mortgages,, your monthly repayments are calculated by the lender, but with credit cards you have the ability to choose what you repay each month. In fact, the only constraint on your repayments is the apparently forgiving minimum repayment figure quoted by your provider.Every card on the market has to prescribe a minimum repayment amount by law. It tells you the smallest amount you are required to pay back each month. In the case that you don’t pay, you’ll be fined.

The minimum repayment on cards varies from provider to provider, but on all applications since 1stApril 2011, monthly repayments have to be at least 1% of the outstanding balance plus any interest accrued on the balance that month. The repayment will also include any fees and default charges. Providers usually also provide a minimum repayment amount for when you’re close to clearing your debt. This is usually set at £5 or £25. As such a typical minimum repayment model could be quoted like this:

  • 1% of the balance plus interest, or £5.

The cardholder will be required to pay off whichever of these is largest each month. Still, with the average outstanding balance running into four figures it’ll be a while before you get down to the £5 figure. The minimum repayments model as opposed to a fixed repayments model leaves consumers in debt for longer, all the while accruing more interest on their balance with the cardholder also making more monthly repayments.

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The Minimum Repayments Trap

With minimum repayments, as you pay off your debt each month your debt will get smaller, but so will your monthly repayments. Therefore, as your debt decreases the rate at which you pay it off slows. This can means that even a small debt will ends up drawn out over a long period of time, costing you a significant amount of money in interest. To illustrate this, let’s look at an example and compare it to a fixed repayments model which avoids this drawn out payments process.

  • Example: You owe £2,000 on a card that charges 18% of annual interest. The minimum repayment is the larger of 1% plus interest or £5.

Now let’s look at how long it will take to repay the debt:

£2,000 of Borrowing Minimum Repayment Fixed Repayment Fixed Repayment
Repayment Plan 1% + Interest or £5 £50/Month £100/Month
Time 24 Years 0 Months 4 Years 11 Months 2 Years 0 Months
Interest £2,593 £940 £359
Time Saved 19 Years 1 Month 22 years 0 Months
Interest Saved £1,653 £2,234

As you can see, racking up a balance of £2,000 on a standard repayment plan can leave you in debt for 24 years and cost you even more than the initial borrowing in interest. Interestingly the first minimum repayment is surprisingly high at £48. Why surprisingly? Because simply repaying £50 each month over the entire course of your repayment, instead of just on the first repayment, you will clear your debt over 19 yearsearlier. You will also save £1,653 in the process. Double this repayment to £100 a month and you’ll save even more.

Save Yourself from the Minimum Repayments Trap with a 0% Balance Transfer Card

If you think you’ll struggle to make a fixed monthly payment over such a long time or if you just want to save yourself money, transferring your debt to a 0% balance transfer deal will really help. By doing this you’ll free yourself up to pay off just the debt you owe, without the constant hassle of interest – after paying a relatively small balance transfer fee of course. The benefits of this are clear to see:

£2,000 of Borrowing Minimum Repayment Fixed Repayment + BT Fixed Repayment + BT
Repayment Plan 1% + Interest or £5 £50/Month £100/Month
Time 24 Years 0 Months 3 Years 5 Months 1 Year 8 Months
Interest £2,593 £42 £0
BT Fee £58 £58
Time Saved 20 Years 7 Months 22 years 4 Months
Interest Saved £2,493 £2,535

With a 30 Month 0% balance transfer dealfor example, on a monthly repayment of just £50 a month you save over £800 more than without the deal and over 20 years worth of indebtedness overall. On a repayment of £100 in fact, you pay no interest whatsoever.

How You Should Repay?

  • If you can only afford to make the minimum repayments

    Set up a direct debit to cover at least the minimum payment on your card. If you miss a payment it will have a negative effect on your credit rating and can also result in your credit card provider pulling your 0% interest deal. A direct debit will stop this from happening.

  • If you can afford to pay off more than the minimum repayment

    Make a monthly payment of a size you’re comfortable with. To avoid falling into the trap of diminishing repayments try to keep this fixed.

  • If you can afford to pay off the debt in full

    By paying off your debt in full you will save yourself hundreds, if not thousands, of pounds in interest. If you can afford to pay it off in full but there are more prudent ways of spending your money then make a monthly repayment of a size you’re comfortable with. And as before, try to keep this fixed.