Minimum Credit Card Payments Are Designed to Keep You in Debt
It’s nice that your credit card company gives you the ability to pay off your balance over time in small, minimum monthly installments. However, while this option does give you flexibility, it is mainly designed to keep you in debt .
A while ago I noticed that one popular issuer actually listed “the ability to pay off balances over time” as an advantage of using their credit card. Nice move, but not so much a customer benefit as a business model. Interest is charged on your revolving balance, which is where credit card companies make money. Most people think so, but Forbes explains the story of how minimum payments are designed to keep you in debt.
In the 1970s, most card issuers required a minimum monthly payment of 5% of the outstanding balance. However, financial services consultant Andrew Car convinced many issuers to cut that number to 2%.
“The lower payments gave customers more flexibility, but“ of course the bank has a potentially much more profitable account, ”he said. When issuers saw how beneficial this change could be, Kara’s innovation quickly went mainstream. By the early 2000s, the 2% minimum rate was the new norm.
In an interview with Frontline, Kar explained what most consumers already know: credit card companies prefer customers who update balances because those customers are more profitable:
… there are cardholders who use the debt, pay finance costs, contribute, cover overheads, provide some profit to the lender. Thus, the one who always pays in full within 30, 45 days, does not bear any commissions, has a free card, the bank does receive some income from this due to the fact that the clearing relations with MasterCard and Visa are structured … but this not enough to cover the costs, or no more than very little … Profits are made from lending.
About ten years ago, federal rules were established obliging issuers to cover fees and accrued interest at minimum payments. This made it at least a little easier for consumers to avoid an endless downward spiral of debt . However, today most issuers only charge 1% of the balance, plus interest and commissions. (Forbes notes that many credit unions and a few large issuers still charge 2%.)
On the other hand, none of this matters as long as you pay your credit card balance in full and on time , which you should try to do anyway to avoid interest and fees. Also, the transmission of this information is not the blame for the credit card companies. After all, a lower minimum balance can help consumers in times of financial stress .
However, if you update your balance sheet every month, it is more helpful to see this flexible “privilege” for what it really is: a plan to keep you in debt. The full Forbes post is worth reading to learn more on this topic, and the full Frontline interview is also available at the link below.
The Secret History of a Credit Card | PBS via Forbes