Using credit correctly not only keeps you out of financial hot water but also helps you build a strong credit history and gain access to more and better credit deals. As the Federal Deposit Insurance Corporation explains, even a single mistake you make with your first credit card can haunt you for years. This is based on the fact that credit card companies share your credit history with the major credit bureaus.
Therefore, understanding the difference between the loan amount, or principal, on your credit card statement and your fees and interest rates will help you build and maintain long-term creditworthiness.
It is worth noting though, that your credit card's APR will dictate how much interest you pay on your principal balance on a yearly basis. You may be forced to pay fees for a variety of reasons, including a yearly usage fee imposed by your credit card issuer.
But usually, credit card amortization doesn’t apply as it would for auto loans, home loans or personal loans. So, you are unlikely to encounter prepayment penalties.
The Principal and the Pauper
Credit card principal is the original amount of money you charge, transfer or advance yourself. For example, if you buy a CD, that goes onto your credit card balance and is part of the loan principal on which your interest is calculated. And if you get money from an ATM using your card or transfer a balance from another card, those are examples of principal.
Many people get into financial trouble and end up paying interest they shouldn’t by charging too many things they absolutely don’t need. Read the terms of your credit card agreement to learn the different rates for different principal balances.
For example, you might pay no interest on the loan balance of a transfer for 12 months, a different rate on purchases you make and a higher rate on money you advance yourself. If you miss principal payments or pay late, your interest rates can change and skyrocket.
Fees Add Up
Credit card companies charge a variety of fees that help them make a profit. Some charge an annual fee for you to have the card. Others apply a fee if you make charges that go over your credit limit. If you miss loan payments or are even a day late beyond the specified loan term, you can rack up more interest charges and fees.
When you transfer a balance, especially if you receive a low-interest promotional period, you might be charged a fee equal to a small percentage of the amount you transfer. Check each statement to see if you’ve been charged any fees in addition to the required payment amount.
Your statement will show your ending balance for the last billing cycle, the charges you made during this billing cycle, interest and fees that have been added to your balance and your ending balance. It will show the annual interest and the total amount of fees you've paid for the principal amount you borrowed for the calendar year.
If you see you've been charged a late or over-limit fee, call your credit card company. If you have a good payment history with a company, it might waive a late or over-limit fee the first time as a courtesy.
Beware of Interest
The amount of interest you pay varies depending on your card’s annual percentage rate, known as the APR, and your balance. Some cards charge a variable rate that changes each time the prime rate changes. The prime rate is the rate that the U.S. Federal Reserve charges its best customers.
Other cards charge a fixed APR that doesn’t change. You will be able to see the interest charged on purchases, cash advances and balance transfers on each monthly statement you receive.
Credit card interest gets people into trouble because it’s tacked on to your balance each month, you don’t have to pay it right away, and you might not realize how much further you’re getting into debt. Some people pay thousands of dollars each year in credit card interest, putting them into a deeper debt hole. If you have a personal budget, include credit interest in your document so you keep an accurate record of your net worth.
Credit Tips and Tricks
Shop for credit cards before you apply for the first one that you’re offered. Some businesses, such as credit unions, offer cards with no annual fees, an interest grace period if you pay your balance within 30 days, low interest rates, balance transfers with lower fees and longer promotional rates than others and forgiveness of some late fees.
Don’t apply for all cards until you’re sure you want the card – each time you apply for a card you qualify for, you temporarily lower your credit score, which can make it more difficult to get the best credit offers.
Once you get a card, sign up for online recurring payments, if possible, to make sure you don’t miss a payment. If you miss a payment, the credit card company might report you to one or more of the three credit reporting agencies that share your credit history with lenders.
To reduce interest payments, pay more than the minimum monthly payment due whenever you can. Your statement will show you how long it will take to pay off your card making only the minimum payment each month and the total interest you'll pay, and what you need to pay each month to pay off the card in three years.
Steve Milano has written more than 1,000 pieces of personal finance and frugal living articles for dozens of websites, including Motley Fool, Zacks, Bankrate, Quickbooks, SmartyCents, Knew Money, Don't Waste Your Money and Credit Card Ideas, as well as his own websites.