How Paying a Credit Card and Credit Card Interest Work

This page will walk you through an example scenario of getting, using, and paying a credit card. Along the way, you’ll learn some common credit card terms and how your actions can impact your credit history. Understanding this page will help you build credit history and avoid late payments while taking advantage of your credit card’s grace period, which is like a month-long interest-free loan.

Some aspects have been simplified so this generally fits most cards, but the specific terms of your card may vary from this example. We’re assuming this credit card does not have a 0% introductory APR. Make sure you read and understand the terms and conditions of any card before you apply.

Get Approved for the Credit Card – June 1

Important Numbers

  • Credit Limit: $1000
  • Available Credit: $1000

New Terms

  • Account Opening Date – The date when you’re approved for the card and the account is opened. You should get the card in the mail within a few days or weeks of being approved, depending on the card or issuer.
  • Credit Limit – The size of the “loan” you have available to spend on your card. This is the maximum amount you can charge to the card before you pay anything back to the credit card company.
  • Available Credit – The amount of your Credit Limit you have available to use right now. Don’t make the mistake of thinking “available credit” means “store credit,” like if you have a gift card for a store! You will have to pay back anything you legitimately spend on a credit card.
Since you haven’t used the card yet, you can still spend 100% of the Credit Limit, so your Available Credit is $1000.

Credit Report Impact

The Account Opening Date is reported to credit bureaus as part of this new account. This date can be used in calculating the average age of your accounts in credit scoring models, which generally favor older accounts. Your Credit Limit is reported to the credit bureaus.

Even though you can spend the full amount of your Credit Limit before you pay anything back does not mean you should. The percentage of your Credit Limit you’re using is a major factor in credit scores. Using a higher percentage is generally worse for credit scores, which is why maxing out your credit cards can quickly lower your credit scores. We’ll discuss this more later.

Make a $600 Purchase – June 22

Important Numbers

  • Credit Limit: $1000
  • Current Balance: $600
  • Available Credit: $400

New Terms

  • Current Balance – How much you owe the credit card company, based on up-to-date use of the card. This may also be known as your Outstanding Balance.

By making a $600 purchase on your card, your Current Balance increases to $600. Your Available Credit is the amount of your Credit Limit you still have available to spend after subtracting your Current Balance.

$1000 Credit Limit – $600 Current Balance = $400 Available Credit

Since your Credit Limit is $1000, your Available Credit is now $400.

Credit Report Impact

Nothing related to this event is reported to credit bureaus.

Statement Closing Date – July 1

Important Numbers

  • Current Balance: $600
  • Statement Balance: $600

New Terms

  • Statement Closing Date – The last day of the current statement period. This is the cutoff for charges and payments to count toward this statement period.
  • Statement Balance – On the Statement Closing Date, your Current Balance, minus any payments made, plus any extra fees charged by the credit card company, becomes your Statement Balance. Your Statement Balance will not change until the next Statement Closing Date.

Credit Report Impact

Your Statement Balance will be reported to the credit bureaus, and this is the balance that will factor into your credit utilization. In this case, you’re using 60% of your available credit ($600 balance / $1000 credit limit). 60% utilization is quite high. To maximize your credit scores, it’s best to use as low a percentage of your available credit as you can, although 1% utilization is technically better than 0%. You can also make a payment before the Statement Closing Date to lower the Statement Balance that’s reported.

Receive Statement (Mail or Online) – July 3

Important Numbers

  • Current Balance: $600
  • Statement Balance: $600
  • Minimum Due: $15
  • Due Date: August 7
  • Next Statement Closing Date: August 10

New Terms

  • Statement – A document you will get in the mail or can view online that provides details about the previous statement period. It includes the Statement Balance, Minimum Due, and Due Date.
  • Minimum Due – Minimum amount you must pay your credit card company by the Due Date to keep your account in good standing, even though you really owe the Statement Balance.
  • Due Date – The date, usually about 25 days after the Statement Closing Date, when a payment is due. For most cards, the Due Date is the same day of the month every month. Sometimes this is based on when you opened the card, but some issuers allow you to choose a different date on which your bill will be due each month.
  • Next Statement Closing Date – The new statement closing date for this current statement period that started after the previous Statement Closing Date on July 1.

The Minimum Due is calculated based on your Statement Balance according to the terms of your card. For this example card, we assume the terms are:

Minimum Due is calculated as 2% of the Statement Balance rounded down to the nearest $1. When the Statement Balance is above $15, the Minimum Due will be no less than $15.

The way credit card minimum payments are structured can be complicated and vary from card to card. The structure of a minimum threshold amount (like $15 or $25) for the Minimum Due that rounds to the nearest dollar or $5 is common. Since 2% of the $600 Statement Balance is $12, but the terms of this card say the minimum will never be less than $15 when the Statement Balance is above $15, the Minimum Due amount in this example is $15.

CAUTION: The Minimum Due is not the credit card company telling you the amount you should actually pay. To avoid credit card debt, you should pay the full Statement Balance. If you only pay the Minimum Due each month:

  • you will pay a significant amount of extra money to the credit card company as interest
  • paying off your debt will take much longer (possibly decades, or you may never be able to pay it off)
  • you may end up with lower credit scores

Credit card companies are not on your side when it comes to the Minimum Due. You may be tempted to only pay the minimum or a slightly higher amount. Credit card companies stand to make the most profit from you as a customer if you only pay the minimum each month.

It may appear that you’re paying 2% of what you owe when you pay the Minimum Due. So, you may think that if you don’t spend any more on the card you will have paid back 24% of what you owe after paying the minimum for a year (12 months x 2% = 24%).

However, during each month you carry a balance you’ll be charged interest on the balance you carry to the next month. Depending on the APR of your card, you may actually accumulate more debt each month when you only pay the Minimum Due. We’ll come back to minimum payments later.

Credit Report Impact

Nothing is reported to credit bureaus as a result of this event (the Statement Balance was already reported on the Statement Closing Date).

Make a $200 Purchase – July 15

Important Numbers

  • Current Balance: $800
  • Statement Balance: $600
Your Current Balance has increased by $200 to reflect how much you currently owe the credit card company. Your Statement Balance is the same as it was on the previous Statement, and won’t change until the next Statement Closing Date.

Credit Report Impact

Nothing is reported as a result of this event.

Pay $500 on Due Date – July 25

Important Numbers

  • Current Balance: $300
  • Statement Balance: $600

Since this statement period has not closed yet, the Current Balance becomes $300 (to reflect your $500 payment) and the Statement Balance remains $600, because that’s what you owed when the Statement for this previous period was generated.

If you don’t pay at least the Minimum Due by the Due Date, your payment may be considered late or missed. If a payment is more than 30 days late, it can have a HUGE negative impact on your credit scores for many years. Issuers will usually wait until a payment is at least 30 days late to report it to credit bureaus. Even if the issuer hasn’t reported the late payment to credit bureaus they may charge you a late payment fee, increase your APR to a penalty rate, or both.

It may look like the issuer is asking you to pay the Minimum Due. With most cards, you will pay interest (lots of extra money) to the credit card company if you pay less than the full Statement Balance you owe. Unlike in this example, you should pay the full Statement Balance by the Due Date to avoid credit card debt and interest payments.

When it comes time to pay your bills, keep in mind that you can easily avoid interest by simply paying off your entire account balance by the due date. This will help save you money and it’s good for your credit scores because it helps you keep balances low relative to your credit limits.

Credit Report Impact

At this point nothing is reported to the credit bureaus. If you were to pay less than the Minimum Due by the Due Date, you risk a late payment being reported to the credit bureaus, which can have a big negative impact on your credit scores for many years.

Statement Closing Date – August 1

Important Numbers

  • Current Balance: $301.67
  • Statement Balance: $301.67
  • Interest Charged: $1.67
  • Minimum Due: $15
  • Due Date: September 7

New Terms

  • Interest Charged – Fees charged by the issuer on debt you did not pay during the previous statement period.

The $600 previous Statement Balance – $500 Payments = $100 remaining unpaid Statement Balance, so interest gets charged on that $100. Assuming 20% APR, the Interest Charged is approximately $1.67. This gets added to the $300 Current Balance, so the new Statement Balance is $301.67 and will be reported to the credit bureaus.

The new Minimum Due is $15. Since the terms of this card say that when the Statement Balance is above $15 the the Minimum Due is 2% of Statement Balance with a minimum of $15. 2% of the Statement Balance is $6.03, but since that’s less than $15 and more than $15 is owed, the Minimum Due is $15.

Credit Report Impact

The new Statement Balance will be reported to the credit bureaus. Your issuer may periodically change the Credit Limit of your account. If your Credit Limit changes, your new Credit Limit will also be reported to the credit bureaus. Remember, your Credit Limit and Statement Balance are important factors that impact your revolving credit utilization, a major component of credit scores.

More About Minimum Payments and Interest

If you don’t use a credit card responsibly by paying the full statement balance each month, it’s easy to accumulate boatloads of interest quickly.

Where is your minimum payment really going?

Here’s an example to show why only making the minimum payment (or close to the minimum payment) can keep you in credit card debt for many years.

Let’s say you have a credit card with an 18% APR and your balance is $10,000. If the terms of the card say the minimum payment is 2%, your minimum payment would be $200.

Keeping the numbers simple, we can approximate the interest as $150: $10,000 balance x (.18 APR / 12 months) = $150

If you only pay the minimum of $200, most of that ($150, or 75%) is covering the interest. Even though your paying $200, you’re really only paying $50 toward the balance you owe.

Some credit cards have APRs in the neighborhood of 24%. If you repeat this same example using that higher APR, the monthly interest is $200. Since the interest is the same as the minimum payment all of the payment is going to paying interest.

Think about how bad that would be over the course of a year: you paid the credit card company $2,400 ($200 x 12 months) and you still owe the same amount you did a year ago.

If you were to increase the amount of debt in this same example, more credit card debt would accumulate each month because the minimum payment would not even cover the additional interest being added each month. You would be deeper in debt each month even though you’re paying the minimum.

How is credit card interest really calculated?

With most credit cards, every time you carry a balance from one month to the next you’ll be charged interest on the amount you carry over.

The interest you’re charged is added to your balance. If you carry any of that balance into the next month, you’ll be charged interest on the remaining balance, including the interest you were charged last month!

This is called “compounding” — you’re charged interest on the entire amount you owe, including any interest owed, every time interest is calculated. This is why it can feel like credit card debt quickly snowballs into larger and larger amounts.

Even though an APR appears to be an annual interest rate, credit card interest is compounded daily, not just at the end of the year or end of the billing cycle.

This means that you’re effectively accumulating more interest every day that you carry a balance beyond your credit card’s grace period.

This is also how you can end up with something called “residual interest” when you think you’re already paid off your entire credit card bill after carrying a balance for a few months.

For example: Let’s say you carry a balance for several statement periods. You get your statement and off the full balance half way through the statement period.

You will still be charged some interest on your next statement. This interest on your next statement is the residual interest. It’s the interest that accumulated on those days in the first half of the month when you were still carrying a balance, before you paid it off.

Luckily, you’ve just finished reading this guide, so you know how credit card interest works and how you can avoid it completely with most cards by paying your statement balance in full. If you found it helpful, please share it with someone else!

If you have any questions about anything discussed on this page, contact us and ask any time.

Was this helpful?

The Insider

John Ganotis
MasterCard® Black Card™ Review: Is it worth the $495 annual fee?
John Ganotis | Mar 01, 2017

The MasterCard® Black Card™ is a metal credit card for people with excellent credit. But are its benefits worth the $495 annual fee?

Read More
John Ganotis
Can I Pay My Taxes with a Credit Card?
John Ganotis | Feb 16, 2017

Read More
John Ganotis
How Can I Get a Free FICO Score?
John Ganotis | Feb 01, 2017

Read More