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How Do Credit Card Payments Work?

By Susan Guillory · March 22, 2021 · 5 minute read

We’re here to help! First and foremost, SoFi Learn strives to be a beneficial resource to you as you navigate your financial journey. Read more We develop content that covers a variety of financial topics. Sometimes, that content may include information about products, features, or services that SoFi does not provide. We aim to break down complicated concepts, loop you in on the latest trends, and keep you up-to-date on the stuff you can use to help get your money right. Read less

How Do Credit Card Payments Work?

If you’re not a seasoned credit card user, you might have questions about credit card payments and their impact on your credit.

Used smartly, a credit card can be a great financial tool, but the key is not charging more than you can afford to pay back and making payments on time each month.

The Benefits of Using a Credit Card

A credit card is convenient if you don’t have cash on hand to make a purchase. As long as you know you can pay back what you charge, either in full or over a few months, a credit card can be a useful tool.

There may also be situations like renting a car or booking a hotel room when you are required to have a credit card to avoid a deposit. The hotel or rental company will place a hold on your card so that in the event of damage or other expenses you need to cover, the company knows you can pay them. With a debit card, you may have that same hold of several hundred dollars tying up your funds for several days.

Another benefit of credit cards is the ability to earn rewards. Many cards give you points for purchases that you can redeem for travel, cash back, or other perks, and if you pay your balance before accruing interest, it can be like the card is paying you to use it.

Potential Downsides of Using a Credit Card

On the other hand, credit cards can cause issues if you don’t exercise good behavior in terms of your credit card payments. Each month, you are charged interest on your purchases. The interest is calculated by dividing your card’s annual percentage rate by 365 to get the daily rate, and then multiplying your current balance by the daily rate.

That may only amount to a few extra dollars a month, but if you don’t pay your balance in full for several months, that amount can snowball, and what you initially charged can easily cost you a lot more.

Another thing to be aware of is the fact that credit card companies charge fees in addition to interest. Some charge an annual fee (usually for cards with rewards programs).

Cash advances come with a fee and a higher interest rate than for purchases.

There are also late credit card payment fees to watch out for. Not only will you be charged a fee if you don’t pay the minimum due by the payment due date, but it may appear on your credit report as a negative mark. This may hurt your credit scores and your ability to take out other financing later.

How Credit Cards Help Your Credit Scores

While a late payment can negatively affect your credit scores, credit card payments made on time can actually help your credit scores.

Each time you make a payment on time, it is reported to credit bureaus like Experian, Equifax, and TransUnion. Over time, on-time payments may factor into the algorithms the credit bureaus use to determine your credit scores, and may raise your number a few points.

Each bureau has its own formula for how scores are determined, and not every credit card company reports to each bureau, so there’s no easy way to know how your payments directly affect your score. But in general, paying on time is behavior that will benefit you over time.

Understanding Credit Utilization

Another factor that goes into your credit scores is credit utilization. This is a calculation of how much credit you have available to access compared with how much you are actually using.

Let’s say you have three credit cards and a total available credit of $15,000. You have a balance of $2,000 across all of them. By dividing the balance by the total credit available, you get 0.133, or 13% credit utilization.

When applying for new credit cards or loans, lenders will look at your credit utilization. If it’s too high—most look for a rate of under 30%—you may not be approved for the card or loan. That’s why it’s important to stay on top of how much of your total credit you’re using and pay down your debt so you don’t have a high credit utilization rate.

How to Build Your Credit With a Credit Card

Once you understand how credit card payments work, you may use credit cards to build your credit, even if you have low scores to begin with. These habits may help you build your credit and improve your credit scores over time.

1. Pay Your Bill on Time Each Month

We’ve covered the importance of making your credit card payments on time. For some people, it can be helpful to put the credit card due date on a calendar (leaving a few days for the payment to get to the company and be processed) to ensure they don’t have late payments.

Many people find autopay, used wisely, a great tool.

If you’ve just received your first credit card, find out how to make credit card payments long before your first one is due, as you might need to set up your bank account information to send an electronic payment, and you want to allow time for that process to be finalized before the due date.

2. Pay More Than the Minimum

If you only charge what you can afford, you should be able to pay off your balance each month, but there may come a time when you have an emergency that requires a larger charge you can’t pay off all at once.

In that case, you may be tempted to pay the minimum amount due, but realize that in doing so, you will pay more in the long run, as those interest charges will snowball. Even if you pay just $5 a month more than the minimum due, you can cut down on interest and pay off your balance faster.

This will also reduce your credit utilization rate and may improve your credit scores.

3. Review Your Credit Report Regularly

Working on your credit involves more than just making credit card payments on time. Access your credit report from Equifax, Experian, and TransUnion (it’s free to do so once a year) and review it for accuracy. Make sure the payments you’ve made are reported as on-time, and look at your list of trade accounts to make sure there are no errors.

For example, maybe you closed a credit card six months ago, but it still appears on your credit report. This is a discrepancy that you can report to the bureau (each bureau’s website has information on how to report a discrepancy). Check again after you report it (allowing for time to process your request) to ensure it has been removed.

Regularly reviewing your credit report will also alert you to any fraudulent activity that might occur. It’s rare, but identity theft does happen, and you’ll want to know if someone is using your identity to open credit cards or take out loans.

4. Only Charge What You Can Afford

Credit cards can be tempting. Without discipline, you might feel like taking a shopping spree, ignoring the financial consequences.

As mentioned as a credit card tip, only charge what you can afford to pay back in a reasonable time frame. A credit card isn’t meant to be free money, and overspending with one can cost you much more than you initially spent.

The Takeaway

Using credit cards responsibly and making credit card payments on time (and in full, when you can) can set you on the path to financial success. The key is to be aware of your spending and your credit utilization so you can help your credit scores grow over time.

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