Where Does a Monthly Payment Actually Go?

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We use credit cards for convenience, to build our credit reputation, and to rake in points and rewards. But let’s be honest: we also sometimes use them as “money” when we don’t have any. As such, they tempt many of us to misuse them – oftentimes into the deepest depths of debt.

The only way to claw your way out is to…

  • Not go down that rabbit hole in the first place
  • Pay your balance in full, each and every month
  • And apply a smart payoff strategy...

…and the only way to achieve that is to understand what goes into a monthly payment in the first place.

What is credit card debt, really?

To borrow a turn of phrase from credit card companies, the actual debt is your ‘revolving balance’. At a very basic level, that means when you use the card:

  • Your balance increases
  • Your remaining credit decreases 

You can either pay the balance off in full, or ‘revolve’ it from one billing cycle to another. When you do this, the lender charges you fees (finance charges and interest) on the outstanding amount that remains. So, essentially:

A credit card statement represents your balance and then some.

Because credit cards generally carry high interest rates, your ‘minimum monthly payment’ might cover little more than the interest charge. That’s more like scratching your debt than putting an actual dent in it. Not only that, but finding your actual credit card balance is not as straightforward as you’d think. Different companies calculate – and, indeed, bury – balances in different ways.

The Adjusted balance method takes the balance due at the beginning of a billing cycle and subtracts payments made during the cycle; new purchases are excluded until the following month.

The Previous balance method reflects the balance due at the beginning of the billing cycle; charges made during the rest of the cycle are totally excluded.

The Average daily balance method calculates the total due each day, then divides it by the number of days in the cycle. Payments are subtracted as they come in; new purchases may or may not be added in.

Other charges to remember:

  • Finance charges can vary wildly according to each method. Check in with your lender!
  • If your monthly payment is late, you’ll not only get slammed with a huge late payment fee but your interest rate might shoot up from a “teaser” deal to the current market rate, or beyond—in some cases rate have risen to over 30%!
  • Take care to stay within your credit means. If you don’t, you’ll get charged with a fee for exceeding your credit limit.

To truly eliminate debt credit card debt, you’ll need to:

  1. Swipe within spending limits to avoid over-limit charges
  2. Pay off your entire balance on time to avoid finance and interest charges
  3. If paying in full is not possible, pay at least beyond the minimum on time to stay ahead of the debt

Remember:

Automate your payments to keep yourself and your credit on track – and always be saving. The road to realizing your financial goals is paved in pennies, not credit card statements and fees.