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:
- The amount you have spent (and not paid off) is your “balance”
- 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.