How Do Credit Card Payments Work: In today’s society, having a credit card is essentially required. Making consistent monthly credit card payments might help you construct a solid credit score and build a credit history if you’re just starting out. What you need to know about credit card payments is provided here.
How Do Credit Card Payments Work
- The minimum payment amount and the payment deadline will be specified by your credit card issuer each month.
- You may improve your credit score and establish a positive credit history by making on-time, minimal payments.
- Your credit card interest will be lowered if you pay more than the minimum amount due. You will not have to pay interest if you pay off your balance in full each month.
What Is a Credit Card Balance?
When you use a credit card to make a purchase, the amount you charge is added to what you owe in total, typically referred to as your credit card’s balance. Your balance is not just the sum of your purchases, however. It also includes the interest you owe on your balance, as well as any fees and penalties the card issuer has charged you. Those may include annual fees, foreign transaction fees, cash advance fees, late payment penalties, and many others, as we’ll explain later.
At the end of each monthly billing cycle, the card issuer will tell you how much you owe, the minimum payment it requires from you, and when that payment is due. By making at least the minimum payment, and making it on time, you’ll stay in good standing with your credit issuer. The remaining balance then rolls over into the next month’s balance and continues to accrue interest. For that reason, it’s best to pay more than the minimum and, ideally, to pay off your balance in full each month.
Making just the minimum payment and rolling your balance over to the next month will not affect your credit score. However, if you’re carrying too large a balance relative to your total credit limit, that can be a problem. Prospective lenders consider your credit utilization ratio in deciding how risky it might be to lend money to you. Someone who routinely maxes out their credit card will seem less financially responsible than someone who keeps a good portion of their available credit in reserve, just in case.
Your credit utilization ratio is also a major factor in determining your credit score. A good ratio is usually 30% or less, so if you have a credit limit of $5,000 on you credit card, for example, you should try to avoid letting your balance exceed $1,500.1
How Credit Card Interest Rates Work
The interest that your credit card issuer charges you is calculated as an annual percentage rate, or APR. Because the APR is an annualized percentage, it is divided by 12 and applied to your outstanding balance each month. For example, a credit card with 20% APR will charge you about 1.67% interest on your outstanding balance each month.
(This example applies to a typical revolving credit card, which allows you to roll your balance over between billing periods. Another type of card, often referred to as a charge card, looks and works much like a credit card but requires that you pay off your balance in full each month.)
Some cards have more than a single APR, such as one for purchases and another one for cash advances. That is all spelled out in the credit card’s terms, which you should receive when you open your account. If you’re shopping for a credit card, you can usually find its terms online.
Credit cards charge a wide range of fees and penalties, many of which are avoidable. But if you aren’t careful, they could end up representing a substantial part of your monthly payments.
Understanding (and Avoiding) Credit Card Fees
Credit cards usually come with a lot of fine print regarding fees, penalties, and other charges you can rack up, sometimes just by accident. Some important ones to know about:
Late fees. If you miss the due date for your minimum payment, you may be hit with a late fee. It can be as expensive as $28 for the first late payment, and up to almost $39 for subsequent late payments.2 What’s more, your late payments will be reported to the credit bureaus and reflected in your credit history, which can be damaging to your credit score.
Over-limit fees. If you exceed the credit limit on your card, your credit card issuer may charge you an over-limit fee. This fee can range from $25 to $35, depending on how often you go over your limit.3 Note that some card issuers will simply decline any charges that exceed your credit limit when you attempt to make a purchase.
Annual fees. This is the yearly fee you pay simply to have the card. Many credit cards are available without annual fees, although those with annual fees may have rewards programs that offer higher rewards on your purchases.
Cash advance fees. Some credit cards allow you to take out cash advances. This fee is usually calculated as a percentage of the cash you receive, and it can be costly.
Returned payment fees. You’ll face this fee if your credit card payment bounces due to insufficient funds or for some other reason.
Conclusion
Credit cards are a good way to build a solid credit history, but it’s important not to overextend yourself and end up in deep credit card debt. If you can only make the required minimum payment each month, that’s better than missing a payment.
But the more of your card’s balance you can pay off, the less you’ll have to pay in interest charges. Paying your balance in full every month, if you can manage it, will provide you with the convenience and other benefits of a credit card, at the least cost.
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