Monday, January 19, 2009

Minimum payments - general concepts

The minimum monthly payment required by your credit card company almost universally includes all outstanding interest charges, fees, and penalties. In addition, a fraction of the principal loan balance is included in the minimum payment. The amount of principal re-payment required differs from one credit card company to the next.

Components of monthly payment:
  1. Interest - this includes all fees and penalties
  2. Principal
Ten years ago it was common practice that 5% of the balance be paid every month. As of 2009, however, the amount may be as little as 1%.

Five percent solution:

This top chart shows the rate of decline in the loan balance over time when 5% of the principle is included in the monthly payment, at a 12% annual rate of interest. On an initial loan of $1000.00 the balance is paid down to less than $200 in about 28 months, and the total interest paid for the loan is about $165.00.


One percent solution:

The bottom chart shows the rate of decline in the loan balance over time when only 1% of the principle is included in the monthly payment, at a 12% annual rate of interest. On the same $1000.00 loan, it takes nearly 81 months for the balance to be paid down below $200. At that point in time the cardholder has paid nearly $400 in interest.



See also: Credit card minimum payments

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