How do credit cards work?

A credit card lets you buy now and pay the bank later. If you pay the full statement balance by the due date each month, you pay no interest at all.

Each purchase is borrowed money

When you use a credit card, the bank pays the store and you owe the bank. A debit card works differently. It takes money straight out of your checking account.

The statement balance is your bill

About once a month the card closes a statement period and adds up what you owe. That total is the statement balance, and it is due on the due date, at least 21 days later.

Paying in full means no interest

On most cards, if you pay the full statement balance by the due date, you pay no interest on purchases. This free window is called the grace period.

The minimum payment is a floor

Paying the minimum keeps the account in good standing and avoids a late fee. Anything you leave unpaid rolls into next month and is charged interest.

Credit card and debit card

The difference is whose money moves. A debit card pulls money from your checking account right away.

A credit card spends the bank's money. The bank pays the store, and you owe the bank. Nothing leaves your checking account until you pay the bill. That is handy, and it is also why a credit card balance can grow without you noticing.

Your credit limit

The credit limit is the most you can owe on the card at one time. If your limit is $2,000 and you owe $600, you have $1,400 left to spend.

A high limit is not extra money. It only shows how much the bank is willing to lend you. Using a small part of your limit also tends to help your credit score, the number lenders use to judge how you handle debt.

The statement period and the due date

Your card runs in cycles of about one month, called statement periods or billing cycles. Every purchase you make during that time is added up. On the last day, the card company closes the period and sends a statement, a bill that lists each charge.

The statement shows three key numbers: the statement balance (everything you owed when the period closed), the minimum payment and the due date. By law, the bill must reach you at least 21 days before the due date, and the due date falls on the same day each month.

How the grace period works

The grace period is the time between the end of the statement period and the due date. On most cards, if you pay the full statement balance by the due date, you pay no interest on the purchases in that statement.

The grace period covers purchases only. A cash advance (taking cash out with a credit card) usually charges interest from the day you take it, plus a fee. Card companies are not required to offer a grace period at all, so check your card's terms.

What happens when you carry a balance

Carrying a balance means paying less than the statement balance. The leftover amount rolls into the next month, and the card charges interest on it. On most cards you also lose the grace period, so new purchases start charging interest right away until you pay in full again.

Credit card interest rates are high, often 20% a year or more. The next lesson, on credit card interest, shows how the monthly charge is worked out and why paying only the minimum can take years.

Paying late or missing a payment

Paying less than the minimum, or paying after the due date, can bring a late fee. A payment 30 or more days late can be reported to the credit bureaus, the companies that keep your borrowing history, and lower your credit score. Some cards also raise your interest rate after a payment more than 60 days late.