What Happens If You Add Money to Your Credit Card?

Adding money to your credit card account may seem like a strange concept since credit cards are meant for borrowing money. But in some cases, prepaying your credit card can provide benefits. Here’s an in-depth look at what happens when you add money to your credit card and whether doing so is a smart financial move.

Understanding Credit Card Prepayments

Unlike debit cards which draw directly from your checking account, credit cards allow you to borrow money up to a certain limit. You can then pay back the borrowed amount over time. Credit cards are not designed to function like debit cards or accept deposits.

However, most credit card companies do allow cardholders to overpay and carry a positive balance. When you pay more than your statement balance, the extra amount is tracked as a credit on your account. Essentially, you are prepaying for future charges

For example let’s say your credit card statement shows a balance of $1,000. But instead of paying the $1000 due, you pay $1,500. The extra $500 will appear as a $500 credit that can be applied towards new purchases or balances in the next billing cycle.

Potential Benefits of Prepaying Your Credit Card

Here are some potential advantages of adding money to your credit card account:

1. Reduce Interest Charges

One of the biggest perks of prepaying your balance is reducing the interest you pay. This is because you are lowering the amount of credit you are utilizing, which decreases the balance that interest can accrue on.

For instance, if your balance is typically $2,000 each month and your interest rate is 18%, you would accrue $30 in interest charges. But if you prepay $1,000, your balance is reduced to $1,000. At an 18% rate, your interest owed would be only $15.

2. Pay Down Debt Faster

Prepaying your balance helps you pay down debt more quickly by lowering your overall balance. In the example above, prepaying $1,000 allowed you to pay off half your debt immediately rather than carrying it over and accruing more interest.

3. Improve Credit Utilization Ratio

Your credit utilization ratio is the percentage of your total available credit that you are using. For example, if your credit limit is $10,000 and your balance is $2,000, your credit utilization is 20%.

Experts recommend keeping your utilization below 30%. Prepaying your balance helps lower your utilization, which can boost your credit score.

4. Create a Buffer Against Overspending

Adding a cushion of funds to your credit card can prevent you from incurring interest if you overspend in a month. Let’s say you prepay $500 but then charge $600. You would only owe interest on the additional $100 since the $500 credit covered a portion of the purchases.

5. Enjoy More Flexible Cash Flow

Prepaying your card creates some wiggle room in your monthly cash flow. Since you have already paid ahead, you could use the money you would normally put towards your credit card on other financial priorities.

Potential Drawbacks of Prepaying Your Credit Card

There are also some potential downsides to keep in mind:

1. Opportunity Cost of Funds

When you prepay your credit card balance, you lose out on the opportunity to invest that money or put it in an interest-earning account like a high-yield savings account. You should consider whether you could earn more in returns than what you would save in credit card interest.

2. Less Consumer Protection

One key benefit of credit cards is they provide more fraud protection and ability to dispute charges compared to debit cards or cash transactions. Prepaying your balance reduces this advantage since you already fronted the money.

3. Potential Impact on Rewards

Certain credit card rewards programs only apply rewards to actual purchases, excluding returns and credits. Thus, any amount you prepay would not help you earn cashback, points, or miles.

4. Risk of Overspending

Having extra funds or credit on your card may encourage you to overspend. Make sure you are diligently tracking your balance and new charges if you do prepay your card.

Best Practices for Prepaying Your Credit Card

If you determine prepaying your credit card aligns with your financial goals, here are some tips:

• Only prepay an amount you can comfortably afford. Don’t tie up too much cash.

• Monitor your balance and new charges closely to avoid overspending.

• Consider cards with no prepayment penalties or that offer rewards on credit balances.

• Compare potential interest savings against earning potential in high-yield savings accounts.

• Use autopay or payment reminders to avoid late fees if your balance is prepaid for several billing cycles.

Other Ways to Pay Down Debt Faster

Aside from prepaying your credit card, here are some other debt payoff methods to consider:

• Make additional principal payments whenever possible. Even small amounts help.

• Transfer your balance to a 0% APR card and pay aggressively during the intro period.

• Consolidate debt onto a lower interest personal loan or credit account.

• Ask your issuer for a lower interest rate or hardship program.

• Stick to a tight budget and funnel all extra income towards balances.

• Consider debt management services for personalized payoff plans.

• Increase your income with a side gig if affordable payments are a struggle.

The Bottom Line

Adding money to your credit card account is an unusual tactic but can provide benefits in some circumstances. It helps reduce your credit utilization, interest owed, and speeds up debt repayment. However, it also carries risks like overspending and losing fraud protections. Evaluate your situation carefully and utilize other payoff methods too. When used strategically, prepaying your credit card can accelerate your path to becoming debt-free.