It is an excellent strategy to find out exactly what is required of a borrower before taking out a credit card. One of the most important aspects of using credit responsibly is learning how to pay back money in a timely manner.
Every credit card has minimum payments that a borrower must make. There are, however, rumors circulating that making only the minimum payments on a credit card may actually hurt an overall credit score. We will take a look at the facts of owning a credit card to see if this is true.
How Much Is a Minimum Payment?
There is an industry standard that usually sets the minimum payment of the average credit card at 2% of the outstanding balance. This is not a hard and fast rule, and there are some credit cards that require less. There are also some credit cards that require more. For the most part, the better your credit score, the lower that your minimum payment will be.
The minimum payment is designed to keep the balance in check while providing a measure of profit for the underwriting bank. Depending on the percentage of the outstanding balance that the minimum payment actually represents, it may never allow for a complete payment of the amount being borrowed. It is not the responsibility of the bank to state whether a minimum payment will actually pay off an entire balance in any time frame. These calculations should be made by the borrower during the period in which he is deciding on a credit card.
If paying off a minimum every month will not ever pay off the entire principal, credit may need to be provided in an ongoing manner by an underwriter. Usually, an underwriter will have no need to report anything to a credit rating agency as long as minimum payments are made on time. The credit score of the borrower, however, is based on more than just the reports of underwriting banks.
What Is the Credit Score Actually Based on?
In order to determine if making the minimum payment on a credit card will actually hurt long-term credit, we must look at what that score is actually comprised of. The exact numbers are a secret of the three major credit rating agencies, so there is nothing set in stone here today. There are, however, ways in which financial professionals can make educated guesses as to any situation. The first is understanding what these scores have been based on in the past.
Part of what long-term credit is based on is the ratio of money that is still outstanding as opposed to the total amount of credit that is being issued to the borrower. If a borrower has an outstanding balance that is more than 30% of his total credit line across all credit cards, long-term credit will most likely be affected in a negative way. If making a minimum payment every month does not reduce this ratio to 30% or less, then the long-term credit will never be able to recover itself.
Another aspect of what affects the credit score is the timing of loans. This is why a big-ticket purchase will hurt long-term credit simply because it is being made. A borrower that is making a minimum payment on a mortgage that does not eventually pay off the principal will experience more of a negative long-term credit effect than a borrower who is making a minimum payment on a bicycle.
If you are expecting to take out a loan on a big-ticket items such as a house or car, then it would probably be in your best interest to begin paying off other credit balances higher rate than the minimum per month. If you hold out and do not pay more than the minimum, then you will likely increase your outstanding balance/total credit ratio to above 30%. You will also likely be paying much less than what is required to pay off the principal as it relates to your total credit. This will cause the ratio to increase even more over time, lowering your long-term credit even more.
The third aspect of what all consumers should consider about a long-term credit report is the amount of credit lines that are outstanding at one time. For most people, a long-term credit report will not be negatively affected up to around five credit lines. If there are more credit lines than this that are outstanding, it may behoove the borrower to begin paying off one or more of them at a rate that is higher than the minimum per month. If a big-ticket item is purchased and the lines of credit are increased beyond the number that is acceptable, the long-term credit report will suffer greatly.
When Is Paying the Minimum Payment Okay?
If you are not in any of the above situations, paying the minimum on your lines of credit will most likely not hurt your long-term credit. This is not to say that you should not endeavor to pay down your lines of credit in case you have a medical emergency or some other unexpected financial responsibility. It is always good to leave some room when it comes to your use of credit.
Borrowers should also consider the difference between secured and unsecured lines of credit when determining whether to pay the minimum or not. Paying the minimum on secured lines of credit is less important than paying the minimum on unsecured lines of credit. First of all, the banks that underwrite unsecured lines of credit are much more likely to report you for an infraction of terms. Some of them may even have the ability to report you for carrying a balance over from month to month even if you do pay the minimum. Check the terms of your agreement to be sure that you are not in this situation. If you are, then paying the minimum only will definitely harm your long-term credit report.
Basically, there is no short answer for the question that is asked in the title. The effect of the amount of money that is paid each month on long-term credit is based on the situation of the individual. Care should be taken to understand the exact nature of your financial situation before deciding to pay the minimum or not.
Just to be sure: You should always pay at least the minimum in all cases in order to avoid financial trouble.
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