Why making credit card minimum payments can hurt your credit rating

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With the rates of disposable income at an all-time low in Canada, you might be one of the hundreds of thousands of Canadians who make only minimum credit card payments each month. While the reality is that might be all you can realistically afford and a minimum payment is all that you’re obligated to make to keep your account in good standing with the lender, over time you won’t be doing your credit rating any favours. That will have an impact on how much you can borrow in the future, if a lender will give you favourable terms and conditions on new credit you apply for and the interest rates you’ll qualify for; even rental, employment or insurance situations can be impacted.

Why is paying only the minimum a big deal?

You might be wondering why making only minimum payments is such a big deal. It’s more than a big deal, it’s a huge deal! In fact, it’s such a big deal that for the past nine years Canadian credit card statements have been required to tell you how long it would take to pay off what you owe if you only made minimum payments and didn’t use the card until it was paid off. If you owe a fair bit on your credit cards you’re likely happy that this note is often buried near the very end of your statements. However, carrying large amounts of high interest credit card debt can have devastating effects on your money management and financial stability. Here’s why:

Balance owing	2% min. payment per month	Years to pay it off	Total interest paid
$7,500	$150	75	$35,550
$12,500	$250	87	$58,818
$25,000	$500	104	$119,489

Assumptions: Credit card APR (Annual Percentage Rate) is steady at 19.9%; minimum payment decreases with balance owing; accurate for illustrative purposes only. In each of the above examples, it’s likely that your debt would outlive you given that Canadians, depending on in which province they live, must be at least 18 or 19 years old to obtain their first credit card. But that’s not the worst of it: High interest credit card debt will impact not only your lifestyle, but your credit rating as well. Here’s how you can calculate your own credit card payments to see where you stand.

Why do minimum payments impact your credit score?

When you make only minimum payments on your credit cards on an ongoing basis, the biggest impact to your credit score is that your balances hardly decrease. You’re essentially not paying off, in a reasonable amount of time, what you borrowed. To understand why this is important, it helps to understand the purpose of a credit score. A credit score is used by lenders to predict how likely you are to repay any new loans or credit they give you based on how you handle your current credit obligations. If you’re not taking steps to pay off what you borrowed before, a lender will assume that you will do the same with whatever they lend you now. There is only so much money to go around and if all of your disposable income is committed to other expenses and debts, your credit score will reflect that your budget is maxed out.

What if your minimum payment doesn’t bring down your balance owing?

Contributing to the never-never plan is the fact that anyone close to their credit card limit may choose to use up their minimum payment amount as soon as it’s applied. For instance, if you have $200 of available credit left on your card and you make your $350 minimum payment, but a few days later you charge groceries, fuel, lunch and dinner while shuttling kids between soccer and dance totalling $450, you haven’t actually allowed your balance to decrease. This is a further indication to your credit score that you have a cash-flow problem. If you are utilizing your credit cards as much as possible to collect points, make sure the points are worth it and you’re not just trying to justify your spending. Collecting points is fine and can be worthwhile, but you never know if or when you need to apply for new credit. It’s wise to keep your credit score on the healthy side so that your options don’t become unintentionally restricted. That means ensuring you use no more than about 75% of your available credit.

How does a credit score impact future borrowing?

A credit score is an integral part of your overall credit rating, and a good credit rating is extremely important when you want to borrow money. Lenders want to ensure that any money they lend will be repaid. Your credit score indicates to them what kind of risk they are taking if they lend you money; the lower your score, the higher the risk. This risk determination then impacts a number of factors, for instance:

How much a lender can lend you
What interest rate a lender or financing company will charge you
Which credit products you qualify for
If there are any specific terms or conditions a lender will need to impose

If you have a lower credit score, restrictive terms or conditions can be baked into the type of product you qualify for, rather than a specific condition imposed by a lender. One such condition can be with regards to a credit card. Some card types limit how much of your credit limit can be used for cash advances versus normal purchase charges. Similarly, with consolidation loans some borrowers will need to consent for their lender to pay off and close paid accounts on their behalf; other borrowers may be allowed to do that themselves or even keep specific accounts open, with or without a reduced credit limit. Another condition a lender may impose based on your credit score is if you require security for your loan or not. If a lender is very concerned about a borrower’s ability to repay a loan, the lender will require a security that is as good as a cash equivalent, such as a non-registered GIC or term deposit, versus an item that first needs to be sold—for example, a car.

Your credit rating can impact broader financial activities

Beyond applying for new credit, your credit rating is also important to prospective landlords, employers and even insurance companies. While they don’t need your credit score if they’re not lending you money, they are among those who want to know how you manage your credit obligations. For instance:

A landlord may want to know if you’re in arrears with previous utility bills or if you have a high car payment that could jeopardize your ability to pay your full rent.
An employer may want to know how stable your financial situation is because when we have financial difficulties, our attention at work can be adversely impacted. For example, we might receive collections calls at work or if we’ve had a poor night’s sleep worrying about our bills, we could be distracted.
Insurance companies may have similar concerns. For example, someone who doesn’t perform proper home maintenance because their budget is tight may file more property claims (such as a leaky roof or flooded drains). Car insurance providers know that someone who is sleepy, stressed and worried will be less attentive behind the wheel. Many insurance companies also provide payment plans for coverage, and those plans are a form of credit.

Managing our money effectively has countless benefits—financial, emotional, psychological and physical, to name a few of the biggest.

What can you control when it comes to your credit rating?

Credit cards can be useful tools when used correctly, so avoid falling for minimum payment myths, the biggest of which is that making minimum payments will get you out of debt. Instead, determine your own minimum payment based on your budget and goals. As long as it is higher than what your credit card statement shows, you’re doing yourself a big favour. Take a look at these examples, based on the same debts from the chart above, to see how a higher fixed monthly payment will save you tons of time and buckets of money.

Balance owing	Increase min. payment by…	Your fixed monthly payment	Years to pay it off	Total interest paid	Interest savings*
$7,500	$50	$200	5	$4,326	$31,224
$12,500	$75	$325	5.2	$7,569	$51,249
$25,000	$150	$650	5.2	$15,138	$104,351

*The interest savings occurs when fixed monthly payments are made that are higher than minimum payments. The easiest way to set up a fixed monthly payment is to review your budget. Determine how much you need to cover off all of your weekly, monthly and periodic expenses. Then consider your discretionary spending. If you’re not sure where your money is going, you might need to track it for a week or two. Once you have an overall snapshot of your budget, see where you can reduce your spending to come up with a steady amount to pay down on your credit card debt. (If reducing your expenses isn’t possible, look into ways to increase your income.) Don’t be discouraged if you can’t come up with a lot of extra money to start with. Even $20 or $100 extra paid down on your credit card debt every pay period will save you a lot of money that can be used elsewhere. By paying thousands of dollars less in interest and fees to your credit cards, you’ll save money that you can use for a nearly endless list of beneficial purchases. from topping up RRSPs, to adding to TFSAs or other savings accounts, doubling up mortgage payments, buying a vacation property, or paying for your kids’ education. If you’re in debt and struggling to get ahead of your minimum payments, don’t focus on your credit score or rating; focus on what you can do right now to decrease your expenses, increase your income, or better yet, do a combination of both. We’ve become so accustomed to making endless amounts of payments on nearly everything we buy that getting out of debt might seem impossible. I can assure you that with some insight into your spending habits, due diligence, a realistic budget and professional help if you need it, you absolutely can get out of debt for good. Scott Hannah is President and CEO of the award-winning, non-profit Credit Counselling Society, which has helped more than 600,000 Canadians since its inception in 1996.