Most savvy people know that one should always pay more than the minimum payment for the month but young people have not always learned that yet. I've often wondered how credit cards determine the minimum amount listed on the monthly bill.
Many credit card companies use the interest plus one percent formula to calculate the minimum payment. This means they take one percent of the current balance and add it to the amount of interest accrued for the month to get the minimum payment unless the balance is $25.00 or less in which case, the minimum will be $25.00. The other way used by some credit card companies is to calculate the minimum payment as two percent of the current balance.
If the card has an interest rate of 15.5% which was the average rate in 2018, it will take 226 months to pay off a balance of $5500 with no additional charges using the first calculation for the minimum payment. Imagine taking almost 19 years to pay off this amount. On the other hand, using the second method to calculate the minimum payment, it would take a person about 290 months or about 24 years to pay it down. In addition, the first method means a person saves just over $2,300 of interest and about 5 years of payments.
If a person has a smaller balance of say $1,000, it will take a person about 57 months using either method because they work out about the same on smaller balances. It is with the larger balances that the differences become more apparent. Although most of the largest credit card companies use the interest plus one percent, many of the smaller ones including Discover use the two percent method. Note that the lower the interest rate, the faster the balances are paid off but it can still take a long time to do it using only minimum balances. Sometimes, any late fees are included in the minimum payment while other times they are added to the balance which again depends on the company.
When a person applies for a credit card, the method of calculation should be located in the pamphlet that arrives with the card, otherwise it should be found online in the person's card account. When in doubt call the credit card company and ask a representative how the company calculates the minimum payment.
This website has some nice activities to show students some basics on balances and the minimum payment. The video showing how to calculate things only looks at a minimum payment of $25.00 rather than either of the above methods but it would be easy to extend the activity to have them calculate the minimum payment using both methods. The second video discusses how much interest is saved when more than the minimum payment is made. The videos are in Edpuzzle so they are interactive and require the student to participate.
In addition, there are additional worksheets so students get to practice calculating interest and balances for other situations. Furthermore, students are required to graph the total interest paid over 5 months and the remaining balance after 5 months for three different people. At the very end, are suggestions for teachers to simplify the work or extend it.
Now, as a teacher you know how they calculate the minimum payment. Let me know what you think, I'd love to hear. Have a great day.
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