How Credit Cards Work

Credit cards are revolving lines of credit. You can borrow up to a limit and pay it back. If you pay the full balance by the due date, you pay $0 in interest. This is the only way you should use them. If you carry a balance, you are charged an Annual Percentage Rate (APR), often 20-30%. Interest is calculated daily. It is some of the most expensive debt legally available.

1. What is a Credit Card?

A credit card is essentially a loan from a bank. They give you a line of credit (say $10,000), and you can borrow up to that limit. You can pay it back in full each month (smart) or carry a balance and pay interest (stupid). The bank makes money in two ways: fees from merchants (2-3% of every transaction) and interest from you (20-30% APR if you carry a balance). If you pay in full every month, the bank only makes money from merchant fees. If you carry a balance, they make money from both. Guess which customer they prefer? The one who carries a balance. That's why they push credit cards so hard. They want you in debt.

2. How Credit Card Interest Works

Credit card interest is calculated daily, not monthly. If your APR is 24%, that's about 0.065% per day. On a $5,000 balance, that's $3.25 per day in interest. Over a month, that's about $100 in interest. But here's the kicker: If you only pay the minimum, most of your payment goes to interest, not principal. On a $5,000 balance at 24% APR with a $150 minimum payment, $100 goes to interest and only $50 goes to principal. At that rate, it takes 5 years to pay off, and you pay $4,000 in interest. The bank loves this. You're paying $9,000 for $5,000 of stuff. The interest compounds daily, so every day you carry a balance, you pay interest on the interest. It's designed to keep you in debt forever.

3. The Grace Period Scam

Credit cards have a "grace period" - usually 21-25 days from the statement date to the due date. If you pay the full balance during the grace period, you pay $0 in interest. This is the only way to use credit cards. But here's the scam: If you carry a balance from the previous month, you lose the grace period. Even new purchases start accruing interest immediately. The bank will tell you that you have a "grace period," but it only applies if you pay in full. If you're carrying a balance, there's no grace period. Everything accrues interest from day one. The bank doesn't advertise this. They want you to think you have a grace period even when you don't.

4. Minimum Payments: The Debt Trap

Minimum payments are designed to keep you in debt forever. They're usually 1-2% of your balance, plus interest and fees. On a $10,000 balance at 24% APR, your minimum payment might be $250. But $200 of that goes to interest. Only $50 goes to principal. At that rate, it takes 17 years to pay off, and you pay $20,000 in interest. The bank designed it this way. They want you to pay the minimum forever. They want you to think you're making progress when you're actually just treading water. Every month you pay the minimum, you're paying the bank interest and barely touching the principal. You're not a customer; you're a revenue stream.

5. Credit Limits: The Temptation

Banks will constantly offer to increase your credit limit. They'll tell you it's "pre-approved" and "won't affect your credit." But here's what they don't tell you: A higher credit limit is temptation. It's easier to overspend. It's easier to get in over your head. And if you do, you're paying 25% interest on a bigger balance. The bank wants you to have a high limit because it means you can borrow more, which means more interest. They're not doing you a favor; they're setting you up. Don't accept credit limit increases unless you have the discipline to not use them. Most people don't. That's why the bank offers them.

6. Rewards Cards: The Illusion

Rewards cards promise cash back, points, or miles. They'll tell you you're "earning" money. But here's the reality: If you carry a balance, you're paying 25% interest to earn 2% cash back. That's a losing trade. You're paying $1,250 in interest to earn $100 in rewards. You're losing $1,150. The math doesn't work. Rewards only make sense if you pay in full every month. But even then, the rewards are funded by merchant fees and interest from other customers. You're not getting free money; you're getting a tiny fraction of what the bank makes from everyone else. The bank loves rewards cards because they encourage spending. More spending means more interest. More interest means more profit.

7. Balance Transfers: The Temporary Fix

Balance transfer offers promise 0% interest for 12-18 months. They'll tell you it's a "smart way to pay off debt." But here's the catch: There's usually a 3-5% balance transfer fee upfront. On a $10,000 balance, that's $300-$500. Plus, if you don't pay it off during the promotional period, you owe all the back interest. And if you miss a payment, the 0% rate disappears. Balance transfers can work if you're disciplined, but most people aren't. They transfer the balance, make minimum payments, and end up in the same situation 18 months later. The bank knows this. That's why they offer balance transfers. They're betting you won't pay it off in time.

8. The Bottom Line

Credit cards are a tool, not a necessity. If you use them correctly (pay in full every month), they're convenient. If you use them incorrectly (carry a balance), they're expensive debt. The bank wants you to carry a balance. They make more money that way. Don't give them what they want. Pay in full every month. If you can't pay in full, don't use the card. Cut it up. Pay cash. The bank will tell you that credit cards are "necessary" for your credit score. They're not. You can build credit without carrying a balance. You can use a credit card and pay it off every month. That's the only way to use them. Everything else is a trap.