How Does a Credit Card Actually Work
You received your first credit card. Now what? You use it! That first credit card does have a limit to the spending though, that is called the credit limit which is the limit on the amount of money you can borrow from the bank. Having a credit card means borrowing money from the bank that you must pay back. Your balance is how much money you owe on your credit card. Let’s think of a scenario, you have a $1000 credit limit, this means that the maximum amount of money you can borrow from the bank at one time is $1000. If you were to spend $100 on new clothes, your balance would be $100. The general goal with credit cards is to reduce that balance by paying money towards the card. Another important term with credit cards is available credit. This is your credit limit minus the balance which gives you the amount of money left to borrow in your credit card amount.
Credit Card Statements
A credit card statement is a report on how your account is doing over a specific period. A few things typically on your statement include: purchases you made, payments you made, fees, possible interest, your statement balance, your minimum payment, and your payment due date. Back to my previous example, if you spent $100 on clothes one month and spent no money on anything else, your statement balance would be $100 for that month. A typical minimum payment is around 2% so, in about a month from the date you received your statement(or sometime earlier or later), you will have to pay $2 to meet your minimum payment.
The Minimum Payment Trap
Minimum payments can make it seem like credit card balances are much easier to pay back than it really is. While paying the minimum payments does keep your account in good standing, the rest of your balance gains interest and becomes larger. This means that smaller purchases that seemed not very costly could cost you much over time. It is very important to not let this happen and be conscious of yourself if you ever want to just pay the minimum. It is very important to understand this trap and not let it turn into a major financial problem.
APR and Interest: Why Borrowing can Cost More
One of the most important concepts of credit cards to know is interest. Interest is the money that banks charge for lending you money. Annual Percentage Rate(APR) is the yearly rate used to describe the cost of borrowing. If your balance is not paid in full, interest may then be added onto the rest of the balance that wasn’t paid back. An example of this would be that you had a balance of $100 and paid back $50 out of that $100. This scenario would leave you with a $50 balance left over which would then contribute to paying more than the original $100 over time as that $50 would turn into more than $50 with interest. This shows the importance of researching a credit card’s APR and how interest works keeping a balance left over.
Credit Scores and Responsible Credit Card Use
Responsible credit card use is central to having a good credit score and can help with a better ability to acquire higher loans later in life and other forms of credit. Some aspects of responsible credit card use are making minimum payments on time, keeping your balance manageable so you can pay it back, and not spending more than you can pay back. A credit card limit does not function as free money so you should never think that you should spend that limit wastefully. A credit card is a very useful financial tool, but it is important to understand how it works and how to use it in a responsible way.