To Get Out of Credit Card Debt, Pay More Than the Minimum Amount Due

As long as you make your credit card payment by the due date, you’ll be in good shape. You’ll be in great shape, though, if your credit card payment covers the full balance that you owe.

But I know times are tough, and there are many of you in credit card debt right now. Be sure you at least make the minimum payment so your account remains in good standing. And when you can, pay more than the minimum to start chipping away at your credit card debt.

So, how do credit card payments work when you pay more than the minimum? You’ll be relieved to know that there are rules in place for how the excess amount is allocated – and some of them work in your favor.

You actually have two balances on your credit card statement: a statement balance and a current balance.

Your minimum payment is generally between 1% and 3% of your outstanding balance. Issuers also set a minimum payment, such as $25 or $35, if your balance is below a certain amount.
Now, here’s the problem: Just paying the minimum on your balance results in an ever-growing balance due to compound interest. Your debt can gradually go from a little bit to a whole lot if you don’t start paying down the balance.

Try to start paying more than the minimum payment. If you have several types of transactions with differing annual percentage rates, it can be confusing to figure out where your excess payment is applied. Luckily, there’s a hierarchy in place that determines how this is done.

OK, it takes a hot minute to explain the rules. To make it easier for both you and me, I’m going to use an example to show you the impact on different balances.

Suppose your outstanding balance is $7,550, and the minimum payment is $150. You want to get rid of your debt, so you decide to pay $300, which is $150 over the minimum.

Now, let’s say you have a $5,000 balance that includes items you bought at the card’s 17.99% purchase APR. And let’s also say you got desperate while shopping and got a cash advance of $1,000. The APR is 27.99%. and there’s a transaction fee of 5%. (Note: Please don’t do this in real life! Cash advances are expensive.)

Here’s how your account looks when I break down balances by type and APR. This is before the $300 payment is applied:

Purchase balance with the card’s regular purchase APR of 17.99%: $5,000.

Balance transfer balance at a 0% intro APR (transfer fee waived): $1,500.

Cash advance balance with a 27.99% APR: $1,000.

5% cash advance transaction fee: $50.

OK, now let’s apply your $300 payment, which is $150 over the minimum payment. The Credit CARD Act of 2009 requires that any amount over the minimum payment must be applied to the balance with the highest APR. Using our current example, here’s how the minimum payment and the excess amount are applied:

Purchase balance at the card’s regular purchase APR: Still $5,000.

The minimum payment is first applied to the balance with the lowest APR. So $150 is applied to the balance transfer balance, which is the lowest APR at 0%:

New balance transfer balance: $1,500 – $150 = $1,350.

Cash advance balance with a 27.99% APR (including the transaction fee): $1,050. The $150 extra amount is applied to the cash advance amount:

New cash advance balance: $1,050 – $150 = $900.

By design, these rules are in place to help you pay down your highest-APR balance once you’ve satisfied your minimum payment obligation.

In this case, the amount of the minimum payment is applied first to your balance transfer amount because that’s the lowest APR. Before the CARD Act, issuers were free to also apply that excess $150 to your 0% APR balance transfer balance. That way, issuers could benefit from the interest you’d pay on the higher APRs. The current system might not be perfect, but it does protect consumers in more areas.

There are multiple ways to make credit card payments. You can set up automatic payments, use online bill pay, make a payment over the phone or stick with a traditional method – mail a check.

A word of caution: Don’t set up automatic payments using an account that often has cash flow issues. Even if you think you’re making the payment on time, if it gets returned for insufficient funds, you haven’t technically made the payment on time.

Whichever method you choose, your goal is to make sure you pay your bill by the due date. Once you have a late payment on your credit report, it really damages your credit score. In addition, it stays on your report for seven years. So make it a priority to have a process in place that you rely on.