When it comes to your financial health, minimum payments on your credit cards are poison.
A $2,000 credit balance with an 18% annual rate, with a minimum payment of 2% of the balance, or $10, whichever is greater, would take 370 months or just over 30 years to pay off.
Making minimum payments on your credit card is a treadmill to nowhere,” says Greg McBride, chief financial analyst at the personal finance website Bankrate.com. During that time, you would end up paying more $4,931 in interest and charges, 146% more than the original balance on the card, according to an online calculator on credit-card comparison site, CreditCards.com.
Most people are unable to make these calculations themselves. When given a similar calculation on how long it would take to pay off a credit card with just minimum payments, only 2% of people were able to answer correctly, according to the survey by TotallyMoney.com. a U.K.-based personal finance website. They also underestimate the amount of interest they’d have to pay off: Only 4% were able to give the correct amount of interest. What’s more, one-third of respondents thought they would actually be able to avoid paying interest by making the minimum monthly payment.
There’s also a broader impact. Around 30% of the FICO credit score is based on how much people owe on their accounts. “Owing money on credit accounts doesn’t necessarily mean you’re a high-risk borrower with a low FICO Score,” according to FICO. “However, when a high percentage of a person’s available credit is been used, this can indicate that a person is overextended, and is more likely to make late or missed payments.” In some cases, showing a very small balance and never missing a payment shows a person is good at managing cards and may be better than carrying no balance at all.
It pays to manage credit cards carefully. And paying off credit cards on a large number of accounts with outstanding balances may also be damaging to your credit score and indicate higher risk of over-extension,” FICO says. “Someone who is close to maxing out several credit cards has a high credit utilization ratio and may have trouble making payments in the future.”
And having no credit cards at all is another no-no, experts say. Credit cards are an essential financial tool when embarking on a career and building a credit history, says Ben Woolsey, president of credit-card advice website CreditCardForums.com.
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