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In today’s fast-paced world, credit cards have become an integral part of our financial lives, offering convenience, flexibility, and a wide range of benefits. Whether you’re a seasoned credit card user or just starting to explore the world of plastic money, understanding how credit cards function is essential.
Just swipe and sign, right? Well, there’s a lot more to how credit cards work than that because, with a credit card, you are essentially borrowing money from a bank that you will pay back at the end of the month.
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How do credit cards work?
Credit cards are financial tools that allow individuals to make purchases on credit. When you use a credit card, you are essentially borrowing money from the card issuer to pay for goods and services. Here’s how credit cards work:
When applying for a credit card, you go through a process with a card issuer, such as a bank or a financial institution. The issuer evaluates your creditworthiness by considering factors such as your credit history, income, and financial stability. Based on this assessment, they assign you a credit limit, which represents the maximum amount you can spend using the credit card.
After receiving the credit card, you need to activate it. Activation typically involves following the issuer’s instructions, which may include calling a designated phone number or activating the card online. Once activated, you can start making purchases.
Using a credit card for purchases is straightforward. You can present your card to merchants or provide the card details for online transactions. Your transactions are recorded within billing cycles, usually on a monthly basis. During this time, you can make multiple purchases, and these charges will be reflected on your credit card statement.
Credit cards often come with a grace period, which is the time between the end of the billing cycle and the due date for payment. If you pay your balance in full before the due date, you can avoid interest charges on your purchases. However, if you carry a balance beyond the grace period, the credit card issuer will charge interest on the outstanding amount. The interest rate, known as the Annual Percentage Rate (APR), varies based on the issuer and your creditworthiness.
It’s important to note that responsible credit card usage can positively impact your credit score. Making timely payments and keeping your credit utilization ratio low (the percentage of available credit you use) can contribute to building a positive credit history.
In addition to the basics, credit cards may offer additional features such as rewards programs, cashback offers, travel benefits, and purchase protection. These features vary depending on the card issuer and the specific credit card you have.
Remember, responsible credit card usage involves managing your spending within your means, making timely payments, and keeping track of your expenses. By understanding how credit cards work, you can make informed financial decisions and use credit cards to your advantage.
Money in a Minute: How Do Credit Cards Work?
Here’s how to make a credit card work for you. A credit card is just a loan. Actually, it’s lots of little loans you can get several times a day. Every time you buy that coffee, lunch or outfit, you’re taking out a loan from the credit card company.
In exchange, that company is charging you interest on those loans. Right now, the average interest rate hovers between 14 and 17%, which is a lot compared to other loans, like mortgages and auto loans.
But here’s the good part: You have a grace period to pay off your credit cards – that’s at least 21 days. So, if you pay off your balance within that time, you’re not charged any interest at all. It’s like someone handed you free money for a month.
Even better, many credit cards offer rewards, whether it’s cash back or points for shopping or airline travel. If you find a good reward card without an annual fee AND you pay off your balances each month, you can actually make money from your credit card.
How can you know how to choose the best credit card for your needs? For many Americans, knowing what to look for to pick the right credit card is a challenge. According to a nationwide survey by major credit bureau Experian, 61% of consumers feel overwhelmed by the “sheer number” of credit card options available when choosing a credit card. Around 57% said they don’t know how to tell if a specific credit card is the best fit for them. That doesn’t mean they’ve given up on finding the right credit card, however. “The majority (64%) believe the perfect card for them is out there, and they just haven’t found it yet,” says Experian. To find the best credit card for you, it’s crucial to look at the details beyond the card’s offer page. One of the most important factors to consider when choosing a credit card is the interest rate. That’s because when you don’t (or can’t) pay off the statement balance due each month, you’ll rack up interest charges. Those charges can add up fast, especially if you’re carrying a high balance. In October 2020, the average APR on new credit cards was 15.97%. Retail card APRs are generally much higher, sometimes even above 25%. To see what a difference the card’s APR can make, punch in some numbers on a credit card interest calculator to see how much you would pay on a balance due amount. If you’ve already signed up for a credit card with a high-interest rate, pay off your statement balance due monthly to avoid paying interest. When looking for a new credit card, you will find the interest rate in the card’s terms and conditions as well as the card offer details. Find out: The Ultimate Credit Card Hacks Guide Before you apply for a credit card with an introductory 0% APR or similar low-interest offer, make sure you know how long the intro period will last. For example, if the 0% APR intro period lasts only six months, you may want to continue your credit card search for a card with an introductory APR period of a year or 18 months. Generally, a credit card offering a 0% APR will promote that information on the page advertising the card and in the offer details. You will also find both the introductory interest rate as well as the new interest rate that will apply after the promotional period in the terms and conditions, sometimes also known as “pricing and terms.” Find out: Which Credit Card Should I Pay Off First? If you want to hit a high credit card balance hard, transferring the balance to a new credit card with a 0% APR for an introductory period for an extended number of months can be a great way to save on interest while paying off the balance. However, make sure you look at the balance transfer fee first. Most balance transfer cards charge a balance transfer free-ranging from 3% to 5 of the amount transferred to the new card. If you will save more on interest than you will pay on the balance transfer fee, the transfer could be a smart move. However, if the transfer fee will exceed what you would pay on interest on your current card, you may want to skip applying for the new card. You can find a card’s balance transfer fees in the credit card terms and conditions. You may get so excited reading about a credit card’s generous rewards program that you jump immediately to the application without noticing that the card has an annual fee. That annual fee may not be just $69 or $99, either. Some cards with super-generous rewards programs charge up to nearly $600 for the annual fee. Always check the offer details and terms and conditions to find out whether a card charges an annual fee before applying. If the card has an annual fee, the issuer will typically charge that fee on your first statement. Many cards with generous rewards programs don’t charge an annual fee, so it pays to take some time to compare cards’ rewards and benefits before applying. Find out: Credit Card Fees and How to Avoid Them Generally, rewards credit cards tout their rewards program on the card’s offer page, since consumers love to rack up credit card rewards for airline miles, hotel discounts or cashback. The card may offer cashback at the end of the year, 5% for travel or 3X points for gas or grocery purchases, for example. Even when the rewards seem clear-cut, however, you need to know the details, including restrictions or requirements. For example, a rewards card may offer higher points each quarter for purchases in certain categories such as gas, groceries or utilities. However, you may not receive those points unless you go on the card’s website and manually “activate” your card during the new quarter. To find the requirements for rewards programs, look in the offer details, often underpricing. You will also usually find information about how to earn and redeem rewards on the card’s Pricing & Information page. When you apply for a major credit card based on a low-interest introductory rate, sign-up bonus, or other special offers, you may be so excited to get those perks that you overlook the card’s many other benefits. Did you know that many credit cards come with travel and shopping protections or additional benefits that can make your life better and easier while saving money along the way? Below are seven credit card benefits you may want to start using right away. If an item you buy with a credit card gets stolen or damaged, you may be able to get some of your money back through the credit card company’s purchase protection benefit. For example, some credit cards offer purchase protection against damage or theft on items you bought with the card for up to 120 days after. American Express offers purchase protection on its cards for up to 120 days and $1,000 per incident, up to $50,000 per year. Next time you purchase an expensive appliance or device, you may want to charge it on your credit card. That’s because many credit cards offer extended warranty protection. For example, when you use a covered Visa Signature card for eligible purchases, the card’s warranty protection doubles the term of eligible U.S. manufacturers’ warranties up to one additional year on warranties of three years or less. Most car rental companies try to sell you a collision damage waiver (CDW), secondary auto insurance on the rental vehicle for the amount not covered by your personal insurance if you’re in an accident during the rental period. However, a couple of credit cards come with primary coverage, which means you don’t have to file a claim with your personal insurance provider for an accident with the rental vehicle. For example, Chase Sapphire Preferred and Chase Sapphire Reserved card benefits include primary (no liability coverage) car rental insurance. If you have an American Express card, you have the option to purchase primary auto rental insurance for a flat rate ranging from $12 to $25 per rental period (not per day) to cover theft or damage to a rental vehicle. If you cut your vacation short or cancel due to sickness, severe weather or other covered situations, the credit card you used to purchase the trip may cover reimbursement. Some credit cards offer reimbursement of prepaid, non-refundable travel expenses up to as much as $20,000 per trip, depending on the card. Ever wish you had a personal assistant to book a hotel in just the right location, make dinner reservations and do the legwork to score tickets to sporting events and concerts? You may already have this service through your major credit card. For example, Visa Signature cards offer free concierge services to manage the details of everything from everyday entertainment to exotic vacations. Select Citi cards also offer a concierge service benefit. You may not have to purchase insurance from your wireless carrier for that expensive smartphone if you pay your monthly bill with a credit card that offers cell phone protection. Several credit cards offer up to $600 protection (minus a deductible) for eligible claims on cell phones that are damaged or stolen. Next time you’re ready to purchase concert or event tickets, check your credit card benefits first for advance access to ticket sales, along with food and beverage discounts. For example, certain Chase credit cards have Chase Select Experience, a benefit that offers preferred seating, pre-event receptions at select events and exclusive dining experiences. When you use your credit card, it’s important to keep your credit card information safe. Many people wonder about the security of their credit card information in this day and age. Credit card fraud is rampant, especially online. So how do you keep your information secure? One way that major credit card issuers helped to make your credit cards safer was by implementing EMV technology in credit cards, which stands for Europay, Mastercard and Visa. Also known as chip-and-pin or chip-and-sign technology, the computerized chip embedded in each card is much more difficult to gather information from when skimming a credit card. Another way to keep your credit card information safe is to avoid saving your credit card information with too many websites. The more sites that have your information, the more vulnerable you are. Thankfully if your card is compromised, you are only liable at most for $50. New technology has also enabled credit card companies to freeze or even deny payments if they suspect suspicious activity on the card outside of your normal spending habits. It’s important to keep track of your spending not just for budgeting, but also to avoid fraudulent attacks. If you’ve never had a credit card before, you’ll need to build up your credit. How to establish credit is somewhat of a Catch 22: You need a credit card to build credit, but you can’t get one without good credit. Luckily, you have a few options. While both roles involve sharing access to a financial account, there are significant differences between them. When deciding between adding an authorized user or a joint account holder, several factors should be taken into account: When using a credit card for the first time, make sure to call the number on the sticker on the front of the card and activate it. Also, make sure to set up an online account with your credit card issuer. Even if you prefer to receive paper statements, having an online account will allow you to view updated information about your account instantly and make changes if needed. Decide how you plan on using your card: Are you going to use it for everyday purchases everywhere, at just one place or type of place? Once you decide, it’s time to make a purchase. Credit cards play a significant role in our modern financial landscape, offering convenience, flexibility, and a host of benefits. Understanding how credit cards work is essential to make informed decisions and use them responsibly. By obtaining a credit card, individuals can make purchases, access credit, and build their credit history. However, it is crucial to use credit cards wisely, paying attention to interest rates, fees, and repayment terms. Maintaining a good credit score and keeping debt manageable are key to maximizing the benefits of credit cards. Ultimately, by utilizing credit cards responsibly, individuals can enjoy the convenience and purchasing power they provide while maintaining financial stability and achieving their long-term financial goals. Article last modified on June 20, 2023. 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Credit card terms to know before applying
Interest rate
Introductory promotional period
Balance transfer fee
Annual fee
Benefits of having a credit card
Purchase Protection
Extended warranty
Primary auto insurance coverage
Travel and luggage insurance
Complimentary concierge services
Cell phone protection
Better access to events and concerts
Credit card security
How to get a credit card with no credit history
Authorized user vs joint account holder
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