How Credit Card Payments Work

So you know how to swipe your card, read your bill, but do you really know how credit card payments work?

First Things First:  How Does a Credit Card Actually Work?

Credit cards are not free money – think of it as a loan.  Every time you swipe your card at the store, you are taking an incremental loan from your borrower – the credit card company.  You will have to pay back this money with interest.

How Credit Card Payments Work

A few tidbits of information first:

  1. The amount you have spent (and not paid off) is your “balance”
  2. Your credit card has an interest rate

Each payment you make to your creditor goes toward the principal (how much you owe) and the interest (a % of the balance the credit card company charges you each month). So, let’s say your minimum payment is $50 on a credit card with a 12% APR – you may only pay $20 toward the principal and the remaining $30 would go toward the interest.  This means that if your balance was $1000, after the payment you would still owe $980 even though you just made a $50 payment.

Most credit card companies do not penalize you for early payoffs or putting more money toward the principal balance.  Even $10/mo can make a huge difference when paying down a credit card balance.