Understanding how credit card minimum payments are set
Issuers vary in how they calculate minimums
Editor's note: See our 2012 survey of card issuers minimum payments, " Survey: Minimum payments haven't changed, but we have"
For consumers, a credit card minimum-payment-due amount can be a mysteriously shifting figure that can make a significant impact on the monthly budget.
The most mutable variable in the credit card minimum payments calculation -- the interest rate -- can rise or fall for many reasons, including whether a customer consistently just pays the minimum each month. What many may not know, however, is that while credit card companies set their own calculations for minimum payments, they are required to do so in a way that allows consumers to pay a portion of the principal, so they can eventually climb out of debt -- assuming they don't keep putting on new debt on their balance.
"They should know that if they choose to make the minimum payment, they are paying down on that loan," says Kevin Mukri, spokesman for the Office of the Comptroller of the Currency, which regulates national banks. "So that should give them some kind of comfort. That debt is not going to get bigger. It's not going to stay the same. That loan amount is going to get paid off. And of course, the more you pay off, the quicker it's going to get paid off."
During an economic downturn, the minimum payment requirement becomes consequential for many more consumers. Typically 4 percent to 5 percent of credit cardholders each month pay just the minimum, according to the American Bankers Association. The organization is expecting this percentage to grow as the economy continues to suffer from layoffs, company consolidations and bankruptcies.
|How minimum payments are calculated|
Below is a sampling of minimum-payment-calculation policies for the nation's largest credit card issuers:Chase -- Greater of the following:
Bank of America -- 1 percent of the new balance, plus finance charges and late fees, if applicable
Citi -- Past fees and financing charges due, plus any amount in excess of credit line, plus the greater of the following:
American Express -- Varies, including 2 percent of the balance on some cards
Capital One -- The full balance, if less than $25, or if more than $25, then 1 percent of balance plus: the current statement's finance charges, if applicable; past due fees, if applicable. If the account is delinquent, the minimum payment will include any past due amount.
Discover -- 2 percent of the balance or a minimum or $15 plus any finance charges or fees
Wells Fargo -- $15; or the entire balance on the account if the new balance is less than $15; or 1 percent of the new balance shown on the billing statement, plus the sum of the fees and finance charges, plus 1 percent of the new balance shown on the billing statement
USAA -- Full balance when balance is $15 or less, or 1 percent of the account balance, plus fees or finance charges, but not less than $15
US Bank -- Greater of the following:
"In this kind of an economy, we expect delinquencies to be up, and we expect people to be paying the minimums because people are losing their jobs," says Nessa Feddis, vice president and senior counsel for the ABA. "In any economic downturn, we would expect that just as a natural consequence."
Lower minimum payments, deeper debt
When it comes to minimum payments, however, things have changed for the better since the last economic downturn. In 2003, federal regulators responded to an outcry over decreasing minimum payments that, in effect, kept cardholders in debt indefinitely by allowing balances to grow through interest accrual -- a phenomenon called negative amortization.
Negative amortization occurs when your monthly minimum payment is less than the amount of interest charged to your account in a month, meaning that those who only pay minimum balances will never pay off their balances. Here's how it works:
- Say your credit card statement balance is $3,000 and your minimum payment due is $20.
- You submit your minimum payment on time and make no new charges on the card.
- During the next billing cycle, the amount of interest accrued on the card balance is $95. (Note: This number is merely used as an example and not meant to reflect any specific APR.)
- Your next credit card statement balance would then be $3,075, with a minimum payment due of $20.
- You submit your minimum payment on time and make no new charges on the card .
- During the next billing cycle, the amount of interest accrued on the card balance is $100.
- Your next credit card statement balance would then be $3,155, with a minimum payment due of $20, and the cycle continues.
This was just part of the problem, however. "It wasn't just negative amortization, but the lowering of minimum payments to the point that it took a very, very long time for consumers to pay off the debt that they owed," says Travis Plunkett, legislative director for the Consumer Federation of America, one of the consumer groups that lobbied federal regulators to change their guidance on minimum payments.
"The issuers did this because it was profitable," Plunkett says. "It allowed them to extend the amount of debt that people owed and to earn more interest income, and because they knew borrowers were more likely to focus on lower minimums and were more likely to pay less."
The government steps in
Federal regulators -- the OCC, the Federal Reserve, the Federal Deposit Insurance Corporation and the Office of Thrift Supervision -- responded to the criticism in 2003 by setting a standard, requiring minimum payments that "will amortize the current balance over a reasonable period of time."
"Prolonged negative amortization, inappropriate fees and other practices that inordinately compound or protract debt and disguise portfolio performance and quality raise safety and soundness concerns," the federal guidance says. The federal guidance set no specific formula, but made clear to the industry that changes were needed.
By 2005, most credit card issuers changed the way they calculated minimum payments in response to the new guidance -- typically 1 percent of the principal balance, plus fees and interest for the month, which usually equates to 2 percent of the balance overall.
Chase, for example, charges its customers the greater of 2 percent of the balance or 1 percent of the balance, plus all interest and any fees. Most of the top 10 credit card issuers calculate their customers' minimum payments similarly.
"Our focus, with regard to minimum payments, is to ensure that customers reduce their balance each month," Chase credit card services spokesman Paul Hartwick says in an e-mail. "And while I can't provide a specific figure, the vast majority of Chase customers pay more than the minimum payment each month."
And some banks are still tweaking their formulas. For example, in 2008, Capital One changed the minimum payment amounts for its cardholders following its move to becoming a national bank regulated by the OCC. It had previously been regulated as a Virginia state-chartered bank.
How high is too high?
Given that minimum payments are still lower than they were during the 1970s -- when minimums of 5 percent were common -- why not just increase minimum payment requirements more? Plunkett of the Consumer Federation says doing that without decreasing interest rates would create a hardship for struggling cardholders in this downgrading economy.
"Sharply raising the minimum in the middle of an economic recession without forgiving some debt or lowering interest rates on debt will send many families over the financial precipice," Plunkett says. "So this is a long-term solution. Long-term, we believe that minimums should be slowly increased, but not in a way that causes financial harm to families who are just getting by."
Linda Sherry, director of national priorities for Consumer Action, which tracks minimum payments calculations in an annual survey, says when credit card companies increased their minimum payment requirements, her organization received many complaints from consumers.
"We believe so strongly that it's a good thing to pay higher minimum payments, but the credit card companies have let people get into debt to this degree, where a household with more than $10,000 worth of debt has gotten so used to paying only the minimum payment on a debt," Sherry says. "When the minimum payment calculations were rejiggered, they ended up having huge jumps in their monthly minimum payment, which, of course, upset people because they were artificially low before."
Most pay more, and banks like it
According to the American Bankers Association, 42 percent of all credit card customers pay off their bill each month, which means 58 percent of all credit card customers carry a balance from month to month. Most of the 58 percent pay more than the minimum, and that's just fine with the banks, the ABA's Feddis says.
"It is a myth when they say banks only want you to pay the minimum," she says. "If someone consistently pays the minimum, that's a red flag to the bank that this person is in some financial distress, and they may not be able to pay the entire balance."
Feddis says the minimum payment, like the credit card, is a tool that can offer consumers flexibility when they need it.
"There may be a time -- there's some sort of emergency and some sort of unexpected expense, you've just lost your job or maybe it was a busy month, it was Christmas -- and you're a little short on funds," Feddis says. "That's when it might be appropriate (to just pay the minimum). That's what it's intended for. Credit cards are intended to be flexible both with the spending and the repayment. And that's just one more aspect of that flexibility."
In fact, Feddis says if customers are consistently paying just the minimum, many banks will reach out to that customer and offer work-out programs to help them through their rough patches.
"Our objective is to work with our customers who are facing financial difficulty," says Betty Riess, a spokeswoman for Bank of America.
Bank of America's minimum payment calculation equates to 1 percent of the new balance, plus finance charges and late fees. If customers are just making the minimum, Riess said the bank will call the customers.
"We have accelerated our efforts to reach out to customers earlier in the delinquency cycle, before their financial situation becomes too distressed," Riess says in an e-mail. "We offer a number of tools to assist customers, such as waiving or ceasing fees and reduced interest and monthly payment programs."
While credit counselors acknowledge that banks recently have been more proactive about reaching out to distressed cardholders, they said the help they offer is limited.
During these days of recession, the National Foundation for Credit Counseling and other consumer groups are asking credit card companies to waive late and over-the-limit fees, offer affordable monthly fixed payments and set the annual percentage rate so that balances will be paid within 60 months.
"Issuers in-house often have their work-out programs with set parameters that fit their business model," says Gail Cunningham, an NFCC spokeswoman. "But those are usually pretty short-lived, usually just a three- to six-month help program."
The NFCC is a nonprofit organization that accredits nonprofit counseling agencies.
Consumers unaware of the risks
Cunningham said many cardholders don't realize that when they pay the minimum, they often place themselves in a higher risk category, which sometimes triggers an interest rate increase. When that happens, a cardholder's minimum payment can dramatically rise along with that rate.
When consumers are finding themselves consistently paying just the minimum, they should call a nonprofit credit counseling agency affiliated with the NFCC or the Association of Independent Consumer Credit Counseling Agencies (AICCCA), says Sandra Shore, a senior counselor with Novadebt, a New Jersey-based AICCA credit counseling agency.
"I think most people, if they're paying the minimum payments, it's because they can't pay more, and they're in financial difficulty and sometimes they don't realize it," Shore says. "They think everything is fine."
See related: Calculator: The true cost of paying the minimum; The not surprising psychology behind minimum payments; Paying less than minimum won't ward off garnishment; Skip those skip-a-payment plans
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