How Do Credit Card Payments Work?

Understanding your bill and how to pay it can cut your credit costs

Reviewed by Pamela RodriguezFact checked by Katrina Munichiello

Having a credit card is practically a necessity in today’s world. If you’re just starting out, making regular, monthly payments on a credit card is a good way to build a credit history and establish a strong credit score. Here is what you need to know about how credit card payments work.

Key Takeaways

• Your credit card issuer will specify the minimum payment you need to make each month, as well as a due date for your payment.
• By paying at least the minimum—and on time—you’ll build a good credit history and raise your credit score.
• Paying more than the minimum will reduce the interest you owe on your credit card balance. If you pay your balance in full every month, you can avoid interest payments altogether.

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. However, you can’t use one credit card to pay off the balance of another card.

Important

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.

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 your credit card, for example, you should try to avoid letting your balance exceed $1,500.

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.

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. A late fee is usually $32 but can vary by card provider and how many times you’ve been late. 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. 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.

What Is a Monthly Payment on a Credit Card?

The monthly payment on a credit card is the minimum payment a cardholder must pay to avoid their card payments from being past due. It is typically calculated on the statement total; usually a percentage of the balance. It could include past due amounts and late fees, as well. It will vary on the provider. If you can, you should pay more than the minimum monthly payment—you should pay the entire balance in order to avoid the high interest charges that quickly grow your credit card bill.

What Are Credit Cards as a Form of Payment?

Credit cards are essentially financing. You are borrowing money to pay for whatever you are purchasing with a credit card. The payment is due at the end of the month and if you cannot make the whole payment, then you are charged interest for borrowing the money you can’t pay back. A credit card is basically a revolving loan.

Do You Pay Interest on a Credit Card if You Pay It Off Every Month?

No, you do not pay interest on a credit card if you pay your balance off every month. Interest is only charged on the amounts you haven’t paid off. If you pay off your entire balance, there isn’t any amount to charge interest on.

The Bottom Line

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.

Read the original article on Investopedia.