That minimum payment looks so inviting when you see it on your account statement. But succumbing to its siren song could very easily dash your ship of finance against the rocks of out of control debt. Here are a few of the many reasons making minimum payments on your debts is a bad idea.
They’re Calculated to Keep You in Debt
The most significant reason for avoiding this trap is minimum payments are mathematically designed to stretch your repayment period out as long as legally allowable. This is done to ensure the creditor can extract the maximum amount of revenue from your loan. Repayment can easily take 10 years or more under minimum payment scenarios.
What’s more, the vast majority of the cash goes to satisfy your interest obligation when you make minimum payments—while making only a small dent in the principal loan amount. Thus, when new interest charges are calculated, any gains the minimum payment may have afforded you will be all but erased when they’re applied to the remaining debt amount.
They Lower Your Credit Score
One of the parameters around which credit rating algorithms measure your creditworthiness is your credit utilization. In other words, they consider how much you owe compared to the credit limits imposed by your lenders.
If you have high balances against which you’re making only minimum payments, you’re likely to be well past the loan amounts lenders consider safe. Further, when lenders see you making minimum payments, they take it to be a sign of impending financial problems.
All of this means lending to you will be looked upon as posing a more significant risk. The greater the perceived risk, the lower the likelihood of a lender being willing to work with you. And, when they are, you’ll be asked to pay a higher interest rate, which will push you even farther into debt.
You’ll Pay More in the Long Run
As we alluded to above, minimum payments are calculated to keep you in debt as long as possible. This means you’ll ultimately pay back a lot more than you borrow.
Consider the following scenario posed by DealNews.com.
Using a simple student loan calculator, the site calculated the difference in interest paid on a $40,000 loan at 6.8 percent interest when the term is eight years compared to ten years.
Under these parameters, payments will come to $546 per month over an eight-year period. This adds up to a total of $52,497, which is $12,497 more than the amount borrowed.
If the loan is stretched out to 10 years, the payment falls to $465 per month, but repayment will total $55,796 if the loan goes full term. This means you’ll pay $15,796 more than you borrowed in the first place. As you can see, even though you’ll be making lower monthly payments, you’ll wind up paying $3,299 more over just two years.
Long story short, there are some very significant consequences to making minimum payments on debt. However, if you’ve found yourself in a situation in which you have no other choice — or worse, you can no longer afford to make minimum payments at all — companies like Freedom Debt Relief can help you get your financial situation back in hand.
They will negotiate with creditors on your behalf in an effort to get part of your debt forgiven. While they can’t help with all forms of debt, finding daylight in some critical areas can often make all the difference in the world.
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