If you’re thinking of applying for a credit card from a lender like American Express, Discover, or Chase, then here is a disclaimer: You need to know the basics about how credit cards work, or you could wind up getting into trouble with interest charges, late fees, and unsecured debt.
As it turns out, nearly half of Americans (47%) have credit card debt, which is a frightening statistic, when considering how hard it can be to pay it down. Credit card debt can sneak up on you very quickly — through a dangerous combination of ill-considered purchases and high interest rates — reaching a point where it becomes impossible to pay off.
At the same time, credit cards, when used responsibly, can be a helpful tool in your personal finance strategy.
In this post, you will learn why it’s important to know the difference between a credit card statement balance and your current balance.
Paying Your s Your Current Balance
Your credit card has a billing cycle, which is typically about 30 days (the length of time between two credit card payments).
The statement balance is a summary of all transactions that occurred within that billing cycle, including any previous unpaid balances. It’s a snapshot of your balance up until the last day of that billing cycle – the closing date.
Your current balance, on the other hand, is a running tally of what you owe right now. If you haven’t yet paid your statement balance, your current balance will reflect that bill as well as any purchases you’ve made since that closing date.
Avoiding Interest and Late Payment Charges
To avoid interest from regular purchases, you need to pay off your statement balance in full each month. Any portion of your statement balance left unpaid will be carried forward with your APR applied – IE, you’ll be charged interest on the unpaid amount.
KEY TAKEAWAY: Pay your statement balance in full each month to avoid credit card interest.
Credit card interest rates are incredibly high, and they increase the total amount you owe.
Let’s suppose you spend $500 over the course of a billing cycle. At the end of the month, if you don’t pay the card in full, you’ll have to pay the full $500 back, plus interest which is calculated based on variable annual percentage rate (APR).
Credit card lenders bank on borrowers steadily increasing their credit by living beyond their means and digging themselves into a hole. For example, one month you may leave $100 extra dollars on a card thinking that you’ll pay it down the next cycle. This can quickly turn into $1,000 or more if you’re not careful.
It’s a dangerous trap that can get progressively worse with each passing month, as you are in a position to pay not only the principal and interest, but also interest on your interest.
Further problems can arise if you forget to pay your bill. If that happens, you’ll get hit with a late payment charge. Don’t let that happen!
The best thing to do when using a credit card is to pay down your statement balance in full. If you can’t do that, consider putting yourself on a budget and limiting your spending.
What Does 0% Interest Mean?
Credit card companies will sometimes offer 0% interest, which is essentially a grace period where you do not have to pay interest on a credit card balance.
0% interest can be very useful if you’re trying to pay down credit card debt. Borrowers will often roll numerous credit cards into one account with a 0% rate, to avoid paying interest charges for a set period of time.
The problem with this strategy is that 0% interest rates eventually end. When they do, borrowers can get hit with very high interest rates. If you weren’t able to pay off all your consolidated debt, you’re suddenly in a worse position than when you took on that 0% loan. Don’t let that happen to you.
How Credit Scores Work
Borrowers sometimes ask why they have to pay back credit cards. What prevents you from racking up a significant amount of debt with no plan to pay any of it back?
What prevents this are credit scores, which are compiled by credit bureaus like Experian, Transunion and Equifax. A credit score is based on a detailed record of your borrowing history. It’s used any time you apply for a loan, like for a car or a house. In fact, some landlords even require credit scores when deciding whether to let you sign a lease.
Credit scores are used for determining your overall credit limit, or the total amount that you’re allowed to borrow at a particular time. If you have a decent credit score and you’re in good standing, you will benefit from lower interest rates and you’ll be given more money to borrow.
If you have a poor credit score, you’ll have a hard time getting good deals and you’ll wind up paying more in the long run.
There are several factors that make up a credit score.
FREE
With Credit Karma you can access your credit score and see what factors are hurting or boosting your score, and to top it all off, its FREE!
Get Your Credit Score
Credit Utilization Ratio
Your credit utilization ratio refers to the amount of credit that you’re using, compared to the total amount of credit that you have. For example, if you have a total credit line of $30,000 across all of your credit cards and you have $15,000 worth of credit card debt, your credit utilization ratio will be 50%, which is very high. As a result, your credit will most likely be negatively affected.
Length of Credit History
The length of credit history refers to the age of your oldest bank account. So if you are 30 years old and you opened your first account at 18, your length of credit history will be 12 years. The longer you build credit, the more your credit history will increase.
Recent Activity
A credit score will also take into account your recent credit activity. This can either be a good thing or it can be harmful to your score. For example, if you use credit cards responsibly over a three-month period and pay off your statements in full, you’ll demonstrate good behavior, which will result in a favorable credit score. If you act irresponsibly, live beyond your means, and miss payments, this likely will damage your credit.
Payment History
Last but not least is your payment history, which demonstrates your ability to pay back what you borrow. Payment history is one of the most heavily weighted aspects of your credit score, as it demonstrates how likely you are to make good on your debts.
FAQs
How can I get a credit card?
When you apply open a credit card account from a lender, the provider will run a credit report and analyze your overall financial situation — taking into account your cash flow, payment history, credit utilization rate, and how many other lines of credit you have open.
The credit card issuer then determines your eligibility and total credit limit based on the information that’s provided. It’s not uncommon to receive a credit card with an available credit limit of $10,000 to $15,000, which is a considerable amount.
However, if you have a low credit score, or if you have several credit cards maxed out, you might not get approved.
Are automatic payments a good idea?
Setting up automatic payments can be a great way to avoid missing deadlines. If you tend to be forgetful and have trouble setting aside the time to pay your bills every month, consider setting up automatic payments. You can choose to either pay your balance in full (the recommended option) or pay a partial amount every month if you have a higher balance than you can afford to pay off.
How do cash advances work?
A cash advance is a short-term loan that you can take against your own credit line. For example, suppose that you have a credit line of $6,000. If your account is in good standing, you may be eligible to take out a certain amount to act as cash.
A cash advance can come in handy if you need immediate access to capital. Just remember that whatever you borrow, you’ll have to pay back with interest.
What’s more, you’ll have to pay back your cash advance in addition to whatever other charges that you rack up on your card in the meantime. It’s very easy to double your debt with a cash advance, if you’re not careful.
When does a billing cycle end?
A billing cycle ends exactly one month from the date that it starts. Billing cycles can start at different times, which can be confusing if you have multiple cards. To avoid missing any payments, keep a calendar handy, or consider asking your lenders to change your billing cycles so that they all fall on the same date.
What is a FICO score?
A FICO score is a type of credit score, created by the Fair Isaac Corporation. This is one of the scores that make up an overall credit report. Borrowers use FICO scores in conjunction with other details to determine overall credit risk. Scores range from 300 (terrible) to 850 (perfect).
Is it wise to pay the minimum amount every month?
When borrowers take out more credit than they can afford to pay, they will sometimes choose to pay the minimum amount every month.
There’s nothing technically wrong with paying the minimum amount every month, but it will take much longer to pay back the loan — especially as interest charges continue to rack up. Making the minimum payment is like spinning your tires; you’ll burn your resources, and you probably won’t make much progress paying down your debt.
The Bottom Line
The bottom line is that when managed responsibly, credit cards can have some useful perks like cash back rewards, travel, and savings opportunities. Credit cards can also help build up your credit over time. But when mismanaged, credit cards can wreck your finances and put you into serious debt that can be hard to escape.
So if you decide to use credit cards, do your research and know how they work. If used responsibly, credit cards can yield some serious benefits.
And now that you understand the difference between a statement balance and current balance, you’ll have an easier time doing so.
#CreditCards
