How do Credit Cards Work?

When you swipe your credit card at the store, that purchase gets recorded electronically with your credit card company. The amount of that purchase is deducted from your credit limit (the maximum amount of money you can spend on that card or line of credit).

At the end of the month, the money you have spent is your “balance”—or what you owe to the credit card company. You can choose to pay the total of what you owe or, more likely, a smaller amount. Your credit card company will establish a “minimum payment” amount—this is the amount of money that you must pay each month against your balance.

But what about those interest charges? Most credit cards come with a thirty-day grace period, which means interest won’t be tacked on until after thirty days have passed. Once that thirty day period has gone by, interest—a percentage of your purchase cost—will be added to what you owe the credit card company.

Remember: the interest (or the cost of borrowing money) will pile up the longer you don’t pay the full balance. So, really, you owe two different amounts. You owe the “principal”, which is the amount you’ve borrowed against your credit card. And you will also owe on the “interest” that the credit card company charges you for the privilege of borrowing money or accessing credit.

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