Freeze Your Minimum
Credit card companies design the minimum payment to maximize the amount of interest you pay. Charging interest is, after all, how they make most of their money. The credit card companies want you to pay off as little of your balance as possible each month so they can sock you with more interest in the long term.
Credit card companies commonly require a minimum payment of only 2-3% of your outstanding balance. Let’s see look in detail at how this measly minimum percentage prolongs your suffering:
We’ll assume that your monthly minimum payment is at least 2% of your outstanding balance, and your APR is 12%. Your monthly periodic rate – the rate of interest you pay each month – is calculated by dividing your annual percentage rate divided by 12 months. Your 12% APR translates to a monthly periodic rate of exactly 1%.
This means that every month, your credit card company adds 1% to your balance in interest. You subtract 2% from your balance by making your minimum payment. After interest is factored in, your minimum payment only puts about a 1% dent in your balance each month. Interest gobbles up about half your payment! Not good, eh?
You don’t have to be a math whiz to see that if you take one step backward for every two steps forward, your progress will be excruciatingly slow – but at least it’s in the right direction.
This problem gets much worse as interest rates increase. At 18% APR, a 2% minimum payment only decreases the balance by about 0.5% (2% - 1.5%) every month. And if your interest rate is 24%, you will never pay off your balance with a 2% minimum payment!
Because the minimum payment amount is so close to the interest amount, even a small increase in your minimum payment percentage could double – or even triple – the rate at which you pay down your debt. And that’s exactly what I’m about to show you how to do. At this point, you must be wondering, “How on earth do you increase your minimum payment percentage without increasing your payment amount?” It’s simple – you don’t.
Turn On the Freezer
Here’s the trick: Never, ever reduce your monthly payment.
The minimum payment you are required to make decreases each month as you pay off your balance. You can check this intuitively – the minimum payment for a $5,000 balance should be about five times greater than the minimum for a $1,000 balance.
Although the credit card company reduces your minimum payment every month, there’s no reason why you have to. Whatever the minimum payment is right now, keep paying that amount! (IMPORTANT NOTE: This strategy only works if you don’t add any new charges. I’m assuming that you aren’t using your card anymore and are trying to pay off your balance. If for any reason your minimum payment due increases, by all means pay it.)
The Results
Here’s an interactive calculator for you to play with. It defaults to $5,000 balance, 17% APR, and a 3%/$15 minimum. Customize the results to your own situation!
The Beauty of the Freezer
For many people, the biggest problem with most debt repayment methods is that they require you to increase your monthly payment. This is money many people simply don’t have. The beauty of this system is that it doesn’t require any extra money. You simply keep paying what you are paying now.
Also, if you find that a decreasing minimum payment prompts you to spend some more, you’re in luck. By keeping you payment’s constant, you’ll quash the urge to keep your balances high.
So what are you waiting for? Freeze your minimum.
