If you’ve come into some extra spending money, you probably already have some idea of how you want to use it. Maybe you want a fresh new pair of sneakers, or perhaps you want to add a bread machine to your kitchen appliances.
With so many possibilities on the table, the last thing you want to do is sink your extra money into your line of credit. Why would you, anyway, when you have the minimum covered?
Relying on the minimum when you have the cash to spare may be convenient, but it’s a big mistake.
What is a Minimum Payment?
A minimum payment is a feature of revolving accounts, which includes your line of credit. It represents the least amount you have to pay to keep your account open and avoid late fines.
In general, the minimum is one of two things:
- A flat fee, which includes a mandatory principal contribution and billing cycle charge
- A percentage of your outstanding balance
What is YOUR Minimum Payment?
So, how is your minimum payment calculated, after all? It depends on your specific line of credit and the financial institution that holds it.
You can find out if yours is calculated as a percentage or flat fee by reading the contract you signed before receiving your funds. You should also see how this breaks down on your monthly statement.
3 Reasons to Pay More
While paying less than your outstanding balance may be tempting, you should budget to pay as much of what you owe as possible. Here’s why:
1. You May Spend Less Money
If you make the minimum, you’ll carry over a balance into the next billing period. Depending on your minimum, this carried-over amount may be subject to interest and fees. These charges will add to your balance, and this new balance will be subject to more interest and fees every time you don’t pay off your bill in full.
Over time, these charges add up, causing you to pay more than if you paid your balance in full. Check out this calculator to see how paying your balance in full can save you money.
2. You May Improve Your Credit
Your balance also factors into your utilization ratio, your second most crucial credit score metric. It represents how much of your line of credit you use, expressed as a percentage.
A 100% utilization is the equivalent of maxing out your accounts, which isn’t a good look. A high utilization ratio may lower your score if your financial institution reports your payment history to a credit bureau.
Generally speaking, a ratio between 0% and 10% has the best impact on your score, although the exact nature of its effects depends on your unique profile.
3. You’ll Be Prepared for Another Emergency
Lastly, paying off your line of credit in full releases your full credit so that you can withdraw funds up to this limit again. This may allow you to cover the next unexpected expense without worry.
Paying your entire balance may not be your idea of fun, but it comes with significant financial benefits. Remember this when you feel tempted to splurge on something — take care of your line of credit first!