By David
As each of us use our credit cards, we become more and more familiar with the credit card system. However what many new credit card users may not understand is why their credit cards monthly payments are so much lower than what they have spent. To help make this easier to understand we’ll take a look at how credit cards work and what that all adds up to.
How a credit card works
A credit card is essentially a means of getting a loan whenever you need or want one. Once you have a credit card, you don’t need to apply for it again, giving you access to additional funds above and beyond your normal income. This money is borrowed from your lender and your future income is used as the collateral. As with any loan, a credit card will charge you interest on your borrowing. The amount of interest charged depends on your cards APR (annual percentage rate) and can vary widely ranging from 8% all the way up to 22% or more.
Interest calculation and minimum payments
The combined value of purchases made with your credit card becomes what is called principle (the amount which interest is charged on). Interest is charged on the principle every day and is then added to the principle meaning that the interest charged on day 31 is going to be less than that charged on day 34.
Your minimum credit card monthly payment is based upon the total balance on your card and tends to vary. However, you should keep in mind that credit card companies are very crafty and set up your minimum payment so it is mostly the interest you are being charged and hardly any principle. This is their way of making the most money from the borrower as possible.
Strategy for avoiding prolonged debt
The best strategy for avoiding continual, prolonged debt on your credit cards is to pay more than the minimum on your credit card monthly payment, preferably as much as you can afford. In this way you are paying not only the interest, but also a larger chunk of the principle thus reducing the amount of interest being charged and allowing you to catch up on your payments. If you do not already have debt built up on your credit cards, one of the best strategies to avoid any significant debt is to only purchase on your credit card what you presently have money to pay for. This allows you to build credit and take advantage of card rewards programs, while still bringing your card back to a $0 balance right away. The best part about this strategy is that it takes advantage of the 30 day no interest grace period inherent on all credit cards.
Now that you have a firmer understanding of how your credit cards work and what your minimum payment is and what paying only it can mean for your financial future, you can make informed decisions about your credit card monthly payments.
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