Does Making Minimum Payments Affect Your Credit Score?

Making minimum payments on credit cards or loans refers to paying the lowest amount required by the lender each billing cycle to keep the account in good standing. While satisfying this requirement avoids late fees and keeps the account current, consistently making only minimum payments can have significant implications for one’s credit standing and overall financial well-being. This article explores how this common practice influences credit scores and the broader financial situation.

Credit Score Fundamentals

A credit score is a numerical representation of creditworthiness, indicating the likelihood of repaying borrowed money. Lenders and landlords use these scores to assess financial responsibility. A higher score generally leads to more favorable terms for loans, mortgages, and credit cards, including lower interest rates.

Credit scores are determined by several components. Payment history, which reflects timely payments, holds the most weight, often accounting for approximately 35% of a FICO score. Amounts owed, or credit utilization, is another significant factor, typically 30% of the score. Length of credit history, new credit, and credit mix also contribute to the overall score.

Minimum Payments and Your Credit Report

Making minimum payments on time impacts payment history. Timely payments, even if only the minimum, are reported positively to credit bureaus, maintaining a good payment record. This prevents late fees, penalty rates, and negative marks on a credit report, which can remain for up to seven years.

Conversely, consistently making only minimum payments negatively affects amounts owed or credit utilization. Credit utilization is the ratio of revolving credit used to total available credit. High utilization indicates a significant portion of available credit is used, which lenders view as financial strain. Experts suggest keeping this ratio below 30% for a healthy credit score; excellent scores are typically below 10%.

When only minimum payments are made on high-balance credit cards, the principal balance decreases slowly. This keeps utilization elevated, lowering a credit score. While timely minimum payments prevent negative marks, they do not lead to an optimal credit score if balances remain high. High utilization impacts persist as long as balances remain high, though scores may recover once lower balances are reported.

Minimum Payments and Total Debt

Beyond the credit score, consistently making only minimum payments has substantial financial implications due to interest accrual. When a balance is carried over each month, interest is charged on the unpaid amount. Credit card interest rates are often variable and high, with average annual percentage rates (APRs) in the U.S. ranging from 21% to 25%.

Interest on credit cards typically compounds daily, meaning interest is calculated on the previous day’s balance, including accrued interest. This compounding effect means a significant portion of the minimum payment often goes towards covering interest charges rather than reducing the principal balance. Consequently, the total cost of borrowing increases considerably over time.

Making only minimum payments significantly extends the time it takes to pay off debt. For example, a balance of $5,000 with an 18% interest rate could take over 20 years to pay off, leading to thousands of dollars in additional interest. Credit card statements often include a “Minimum Payment Warning” box, which estimates how long it will take to pay off the debt and the total cost if only minimum payments are made. This prolonged repayment period means consumers pay much more than the original amount borrowed.