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Credit cards: What to know about minimum repayments and credit limits
Credit cards have many advantages: they allow you to make purchases when you may not have the cash immediately available; they could help you build up a solid credit history if you use them properly; and they can provide you with protection on purchases that cost over £100. However, the key to getting the most out of borrowing is to use your credit card responsibly.
Of course, one way to do this is to shop around and look for the best rate available to you. However, once you have secured your credit card, another way to ensure you use your plastic in the most cost-effective way is to fully understand what the credit limit and minimum repayment on your card are. Read our guide to get a better understanding.
Credit cards may offer many incentives to borrowers. Some let you exchange points for rewards, others let you collect Air Miles, and there are those that give you cashback. The incentive you choose comes down to your own personal circumstances and what you think will benefit you most.
Perhaps the main draw of credit cards is that they provide you with the ability to purchase goods even if you don’t quite have the funds you need available in your account - say if you’re £10 off and it’s the day before payday. The catch is that you are charged interest for your borrowing.
However, there is a way to enjoy the benefits of owning a credit card without being saddled with all the interest – by paying off the balance in full each month within the allotted interest-free period. While the exact terms can differ by lender, it’s common for borrowers to have up to a 56-day window in which they can pay off their credit card balance without being charged interest. So, if you borrow £50 and pay it back on or before the due date given on your statement, the amount you pay back is £50.
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You don’t have to pay the full balance on your credit card each month, although this is the cheapest way to use it. As long as you make sure you pay the minimum repayment you won’t be breaking the terms of your agreement, or getting into arrears – and the minimum repayment charge can be quite low. For peace of mind, you can set up a Direct Debit for the minimum repayment so that you know it’s covered every month and you’re not at risk of missing it.
However, be aware that only paying this means it will take quite some time to clear your balance – and it could end up costing you a lot in interest.
Let’s take a closer look at what exactly it means to only make the minimum repayments on your credit card:
Outstanding balance: £1,000
Interest rate: 34.9%APR
Making the minimum payment that is equivalent to the greater of 1% on the balance plus interest; 2.25% of the balance; or £5, it will take you 20 years and five months to clear the debt.
Total cost: £1,000 plus £2,279 in interest.*
While you’re paying such a small sum each month towards your credit card debt, it will end up taking you a long, long time to clear the balance in full – perhaps even decades. In addition to it taking you longer to get debt-free, you could also end up paying back a large sum of interest – more than double what you borrowed in this case.
But you can always pay more
You might not be able to pay off the full balance of your credit card each month, but every penny you pay above the minimum repayment threshold should help reduce the time it takes you to clear the debt and the amount of interest you pay.
Let’s look at what the difference would be if you repaid £50 a month towards the card in the earlier example, rather than just making the minimum repayment:
Outstanding balance: £1,000
Interest rate: 34.9%APR
Making a fixed monthly payment of £50, it will take you two years and five months to clear the debt.
Total cost: £1,000 plus £410 in interest.*
So, that’s an interest saving of £1,869 and you’ll pay the balance off 18 years sooner than if you just paid the minimum! As you can see, a minimum repayment charge really is just a minimum and you should always aim to pay more – even if it’s only a bit more.
Carefully work out how much you can afford to put towards your credit card each month – which, ideally, should be whatever you spend on it or close to that sum – and set up a Standing Order for this amount. That way you’re making good, regular progress paying down your debt.
Spending to the max
The upper spending limits on credit cards can be very enticing. They might reach to several thousand pounds, and when you don’t have that type of money regularly available it can be tempting to spend it all.
However, maxing out your credit card is not good for your credit score. Your score takes into account how much credit you have available to you and how much you’re using – and if you have used up every last penny it could stand against you. Not to mention, future lenders may not look favourably on someone who has taken out a credit card, maxed it out and then applied for a new one.
Another thing to beware of is possible penalties if you go over your maximum limit. If you’re not sure exactly how much you’ve spent but know it’s close to the limit, one small purchase could push you over that. Many providers charge £12 for going over your limit**, and you may also lose any promotional interest rates you’ve been taking advantage of.
All of this should not put you off getting a credit card if you want one. They can be useful additions to your wallet – as long as you use them responsibly.