The Credit Implications of Paying the Minimums on Credit Cards

One thing that has always boggled my mind about the America education system is that we don’t have mandatory classes on credit. Think about it. Chances are for 99% of our population that high school Chemistry class they took in 11th grade turned out to be pretty useless in their adult lives. In no way am I advocating that we drop Chemistry from our curriculums, but it’s completely unreasonable that we cannot find the funding or space for a mandatory course on credit. To be honest, it’s the one thing that’s useful for us all---from the chemist to P.E. instructor---and when you factor in that banks are increasingly targeting 18 year old college kids with credit card solicitations, it makes even more sense to educate the younger population about the appropriate use of credit.

The most common misconception about credit is that the only thing that matters is your credit history---whether you’ve made payments on time and fulfilled your financial obligations in a timely manner. Sure your payment history is important, but it still only composes just over one-third of your credit score. Moreover, your payment history is only reflected in your credit score. Lenders look at the whole financial picture. Does this person have a sizeable down payment? Will this person be able to reasonably afford this monthly payment given their income? Does this person have assets that they can liquidate in the event that they can no longer afford the payment?

When someone is toiling paying the minimum payments on high interest credit cards, they are doing very little to help their credit worthiness. Yes, they’re helping their credit history, but in the process their credit is presumably being affected negatively by their high outstanding debt amount. If you think that you can fool a lender into thinking you’re financially healthy when you’re only able to afford the minimums on your credit card, then you’re wrong. These people are experts at deducing who is good loan candidate, and if you’re paying 25% or more of your monthly income on credit card minimum payments, then you’re probably not the best loan candidate in their eyes.

Why? There are a couple reasons. First and most obvious is that you might not have sufficient income to afford the loan payment as well as your credit cards. Secondly, think about what it means when someone is paying just the minimums on high interest credit cards. It means that this person is willing to throw thousands of their hard earned cash down the drain on finance charges. Sure, they’re honoring the creditor and at least making the minimum payments every month, but is this the type person that you would trust to be 100% on top of their long term budget and financial situation? Despite what the cynics say, most people are honorable and want to be able to pay back their debts. (Creditors know this too---otherwise they would not be in the business of lending money.) A fewer number of people are able to budget properly and have safety nets available in the event that they are short of cash in the future. Someone who is willing to pay just the minimums on high interest credit cards may not the kind of person that has effectively budgeted for “rainy day”.

Well, if paying the minimums does not help your credit-worthiness, what is it good for? Let’s see. It causes undue emotional anxiety about being able to pay the bills, so it definitely does not help your health. It depletes your income and prevents you from being able to save money every month, so it definitely does not help your financial picture. The only time I can ever see making the minimum payments as a viable debt resolution option is when you’re expecting a sudden surge in income sometime in the near future. For example, it’s February and you’re expecting a big tax return that will help you eliminate the debt quickly, then by all means make a few minimum payments until you get that check from the IRS. If it’s October and you’re confident that your year end bonus will be enough to satisfy the debt, then hunker down for a few months to buy some time. The bottom line, however, is that making the minimum payments on your credit cards is not a long-term debt elimination strategy.