Monday, September 10, 2012

How Do Credit Cards Work?

Ahh, like magic, you hand over your newly-acquired credit card and leave the store with a brand new sound system. What a racket! But, the joke's on you when you get your credit card statement the next month. Credit can be a great way to access what you need when you need it, but it can also turn your life into a collection-agency nightmare if you're not careful.

So, how do credit cards work?

Most people don't think about their credit cards other than to make purchases and pay the bills. But, there's a whole process that goes on behind the scenes involving you, the merchant, and the credit card company.

The Purchase
When you make a purchase with a credit card, the credit card company puts the amount of the purchase (less the fees that the merchant has agreed to usually 2-3% of the amount of the sale) into the merchant's account. At the same time, the credit card company also posts the same balance to your credit card account.

For example, if you use your credit card to make a .00 purchase, your card issuer will pay the merchant .00 (less fees) and add .00 to your account. If you carry a balance on your card, you'll immediately start to pay money on that amount. If you don't carry a balance on your account, the bank floats you a loan through the statement and payment periods of your billing cycle.

The Statement Period
The statement period is your cut off dates for charges. Any purchases you make during your statement period will be reflected on your bill. If you buy something after your statement date, but you haven't yet received your credit card bill, the purchase will show up on your next bill.

Based on what you've charged during your statement period and your previous balance (if any), the bank tallies up the balance of your purchases, the interest charges on those purchases, plus any additional fees and determines how much you owe and when your payment is due. Your payment is usually due on the same date each month.

The Payment Date
If you pay for the purchases you charged in full each month before the due date for your card payment, you will not be charged interest on those charges. If you do carry a balance on your card, your card company begins to charge interest the day after your scheduled payment is due.

Paying your balance in full each month before the payment date is the least expensive way to use your credit cards. Remember, while you're in one payment period, you've already started another statement period, so your balances continue building and the process repeats.

Knowing how credit cards work can help you understand the best way to use them. It is important to your financial future to maintain a good credit standing with your creditors. Lose the credit game and you'll literally pay the price in lost credit opportunities and higher interest rates on credit-based purchases.

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