When signing up for free airline miles or cash-back rewards, most people do not consider the potential dangers of credit card debt. Credit cards help build credit, protect against unauthorized charges, and offer useful benefits when used responsibly. However, if not managed well, credit cards can lead to a dangerous debt trap. 

How do credit cards work? Credit cards let people borrow money and pay it back later. 

“For the most part, using credit cards and understanding how credit card companies work are pretty straightforward,” said Todd Ossenfort, Chief Operating Officer of Pioneer Credit Counseling. “Just remember, you are expected to pay back any money you spend when the monthly statement comes.”

People can choose to pay back the full amount each month or pay a minimum amount of the balance due. 

When paying off the full credit card bill each month, credit cards can help people build good credit. They may also offer perks, such as mileage awards, cash back, or other rewards. On the other hand, if you choose to pay just the minimum payment, only a small portion of your payment goes toward your debt. Most of your payment will go to paying interest. Since credit cards carry high interest rates, it can take a long time to pay off debt when only making the minimum payment. 

If you miss a credit card payment, then the bank can charge you interest on top of the original payment owed. If this happens repeatedly, the interest can grow significantly or “snowball,” meaning you will owe more and more each month. People refer to this as a debt trap, and it can hurt your credit score. 

How do credit card companies make money? Credit card issuers are banks and credit unions that allow you to borrow money from them based on certain terms and conditions. Issuers make their money from interest and fees charged to cardholders. 

Credit card issuers often pair with a network company, like Visa or Mastercard. Network companies authorize and process credit card transactions. They earn money from transaction fees paid by businesses that accept credit cards. 

Most of credit card issuers’ revenue comes from interest charges on credit card balances. High interest rates on credit card balances are the biggest cause of ongoing credit card debt for consumers. 

Fees also generate revenue for the credit card companies. Some common fees include annual fees to use the card, cash advance fees, balance transfer fees, and late fees.