How Do Minimum Payments and Late Fees for Credit Cards Work?

Credit cards can come in handy for those who are short on cash but need to make certain purchases immediately. This can be especially important during emergencies. As long as one makes their monthly minimum payments in order to avoid late fees, one's credit score should not be negatively impacted. However, in an unpredictable economic environment, it is important to understand how minimum payments and late fees for credit cards work in order to avoid financial problems in the future.

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What Happens If You Fail to Make the Minimum Payment on a Credit Card?

Usually, your monthly minimum payment on your credit card is a small percentage of the balance owed on the account. It is the bare minimum you are legally obligated to pay for each monthly bill. Failure to pay the minimum payment amount by the due date could result in late fees as well as a penalty annual percentage rate (APR).  If you fail to make the minimum payment, the issuer can legally report your account as delinquent, which would negatively affect your credit score.

What Happens If You Only Make the Minimum Payment on Your Credit Card?

Only making a minimum payment can be a good thing when you are having trouble making ends meet for the month. However, continuing to only make a minimum payment every month, will cause you to pay more interest charges in the long run. This can become a serious financial problem over time, particularly if the credit card issuer charges high interest rates.

Although making just the minimum payment helps you avoid late fees, you will not be making much progress on paying down your balance, ensuring that you will continue to be in debt to the credit card issuer for a long time. Credit card companies usually set the minimum payment amount at the lowest level possible, which is usually around $25 or a small percentage of the leftover balance, whichever is greater. Some credit cards only ask for a payment of 1% to 2% of the balance every month, plus accrued interest and any fees. This is designed to encourage you to stay in debt to the credit card company for as long as possible, which is more profitable for the issuer in the long run.

Digging a Deeper Hole

Unless you have a credit card with a 0% APR, making only a minimum payment on your credit card will only cause your balance, along with your interest charges, to grow. Basically, you will only be barely wiping out interest charges from the previous month. If you continue to make charges to your credit card, your balance will increase, and you will dig yourself deeper into debt.

Detrimental to Your Credit Score

Even if you never miss a single minimum payment deadline, having your account balance continually increase, can still hurt your credit score. This due to your credit utilization ratio, which is the percentage of your available credit you are currently using. Your credit utilization ratio is a significant factor for credit rating agencies when they are calculating your credit score.

Therefore, high balances can make it more challenging for you to qualify for favorable terms on credit cards as well as other affordable loans. In some cases, it can even be detrimental to your ability to rent an apartment or find employment. It is not uncommon for landlords and employers to look at an applicant's credit report. Ideally, it is best practice to utilize less than 30% of your available limit on any credit card. Using less than that is even more preferable.

How do Late Payments Affect Your Credit Score?

Making a payment on your monthly credit card bill, that is only a day or two late, will likely not have any effect on your credit score. In theory, you could be hit with late fees for being even 15 minutes late on a monthly payment. However, this does not mean your credit score will be negatively affected.

Credit bureaus, the entities in charge of calculating your credit score, do not count a payment as late until it has been at least 30 days overdue. In fact, credit card issuers are not even allowed to report the payment as late if it is less than 30 days past due. Federal law prohibits credit card companies from intentionally and knowingly reporting a bill as late when it is less than 30 days past due. Doing so can result in serious legal problems for the credit card issuer.

Rebuilding Your Credit Score

If you are 30 days late on your credit card bill, it certainly is not a good thing, but it is not the end of the world. Being 60 or 90 days late is significantly worst for your credit score. Therefore, you should catch up with your credit card bill as soon as possible. This will help to mitigate the damage to your credit score and will allow you to begin rebuilding your credit history faster. The longer you wait, the more damaging it will be to your credit score and financial health.