Hidden risks of credit card minimum payments: How users can escape the debt trap and boost their credit scores

Credit cards are financial instruments that offer flexibility, convenience and seamless digital payments. However, relying too heavily on paying only the minimum amount due can lead to a dangerous cycle of debt.

While making only the minimum payment might seem like a short-term solution to avoid late payment penalties, it carries serious risks for credit card users in India.

Let us examine this common pitfall, the minimum payment trap, in detail. It can force credit card users into mounting debt, leading to a loss of financial credibility, a drop in trustworthiness, and a significant decline in credit scores.

Minimum payment trap

The minimum payment due is generally 5% of your total outstanding balance on your credit card, along with processing fees and interest. For example, If your credit card bill is ₹1,00,000, then the minimum payment might be ₹5,000.

While making this payment keeps your account in good standing, it does little to reduce the principal amount owed or improve your credit utilisation ratio. The remaining balance continues to build and accrue interest, often as high as 40% to 42% annually, which compounds the debt over time.

If not checked and cleared, this growing interest can spiral out of control and push credit card users into an endless debt trap. Over the long term, it can severely hamper credit profile.

Impact on financial health

Focusing on paying only the minimum amount can create a debt spiral. The situation can easily go out of hand if you miss out on one payment or cannot pay the minimum amount in subsequent instalments. Such developments are not good for your credit health.

• High interest costs: A major portion of your payment goes towards interest repayment instead of reducing the principal amount. This is not a healthy repayment position. It comes with the grave possibility of this interest amount snowballing into larger debt later.
• Loss of interest-free period: Any new purchases on your credit card in the future will no longer enjoy any interest-free period, thus further increasing costs.
• Longer and dragged repayment period: Following this process, clearing your credit card debt can potentially take years, resulting in costing thousands in interest alone.
• Lowering credit score: Higher credit utilisation, along with prolonged repayment periods, negatively impact your credit score and credit profile. This will make any future loan applications or credit card approvals more challenging.
• Emotional stress: The idea of surviving on minimum payments is nothing but the admission of dependence on debt for basic needs. Such a simple-looking idea can appear lucrative, but it can also bring high EMI bills and very high interest rates. The psychological stress of meeting such high charges on a weekly to monthly basis can stretch your finances.

Unable to manage debt, young Indians are falling into rising defaults

India has recently seen a surge in credit card defaults. This is particularly prevalent among millennials and Gen Z. Many young borrowers are attracted by easy-looking EMI options and buy now and pay later schemes.

They fall into the trap of only paying only the minimum due, which has contributed to rising defaults. Total outstanding credit card dues, for example, reached ₹2.7 lakh crore by June 2024, reflecting a 24% compounded annual growth rate over the last five years.

Avoid falling for the minimum payment debt trap

• Focus on paying more than the minimum due each month.
• Avoid needless spending and focus on conserving your credit card limit.
• Keep your credit utilisation ratio below 30% at any cost.
• Prioritise clearing high-interest debts first.
• Reach out to experts to discuss basic concepts of debt management.

Hence, the allure and thrill of minimum payments and easy credit card usage is deceptive. It comes with serious consequences of debt build-up. Therefore, understanding the risks of credit card debt build-up and adopting responsible and well-planned repayment habits can help boost your financial security and peace of mind.

You should only go for credit cards, personal loans or any other credit instruments when you have no other options. As such, credit instruments come with high interest rates and a serious threat of falling into an endless debt trap.

Disclaimer: Mint has a tie-up with fintechs for providing credit, you will need to share your information if you apply. These tie-ups do not influence our editorial content. This article only intends to educate and spread awareness about credit needs like loans, credit cards and credit score. Mint does not promote or encourage taking credit as it comes with a set of risks such as high interest rates, hidden charges, etc. We advise investors to discuss with certified experts before taking any credit.