If you’ve been wondering, “How do credit cards work, anyway?” here’s a guide to get you up to speed. Once you get the hang of them, you’ll find that credit cards are incredibly helpful financial tools.
American Express Cobalt Card
American Express Cobalt Card
Purchase interest rate
Eligibility criteria, terms and conditions, fees and charges apply
American Express Cobalt Card
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Purchase interest rate: 19.99%
Cash advance rate: 22.99%
Annual fee: $120
Credit rating: Fair, Good, Excellent
Minimum age: Age of majority in province/territory of residence
A credit card is a small plastic card that lets you borrow money from a financial provider. If you borrow funds for a significant period of time, you’ll pay a fee for the privilege of borrowing — this is called interest.
Using credit cards are a secure and convenient way to pay both online and in person. They’re also excellent tools to build your credit score — a 3-digit number that represents how reliably you’re expected to pay your debt.
Beware: A credit card isn’t free money. You’re always expected to pay back whatever you borrow. There will also be a maximum limit to how much you can borrow at a time.
How do credit cards work?
Here’s how they work from getting one in the first place to paying your balance and maintaining your credit score.
Apply for a credit card. There are many different types of credit cards. Choose one based on which benefits you want, as well as your credit score and annual income. A credit card may have an annual fee — a fee you have to pay once a year to remain a cardholder. The most powerful cards with the highest spending limits and perks often have this fee, but you’ll find many great cards without it. You may see an introductory annual fee offered for the 1st year. This means you’ll pay a discounted fee for the first year and the normal annual fee every year thereafter.
Wait for approval. Major credit card providers often use automated decisions on card applications. You may see the results of your application immediately. If the provider needs to review your application further, you could wait 7 to 10 business days. Upon approval, look for your card in the mail within 7 to 10 business days. Then follow the enclosed instructions to activate your card. Congratulations — you’re ready to start using your first credit card!
Make purchases with your card. You can spend with your card by swiping it through a card reader. If your card has a chip, you’ll insert it into a card reader. You can also pay by tapping your card on terminals that are equipped with contactless payment technology. To spend online, enter your card number and additional information such as the expiration date, billing address and card verification code (CVC). As you spend, you’ll add to your card’s balance — the amount you’ve borrowed on your card but have not yet paid back. Your card provider will have set a maximum balance you’re allowed to have at any given time, which is called your credit limit.
If you try to make a purchase that puts you over your credit limit, the transaction will usually be declined.
You can ask your card provider to allow charges over your credit limit. However, you’ll typically be penalized with a fee each time you exceed the limit.
Wait for your credit card bill, issued at the end of your billing cycle. Using your credit card means you’ll be repaying your credit issuer later for your purchases. But when do you have to pay? First, know when your billing cycle — the time between credit card billings — starts and ends. It can be from the 1st to the 30th of the month, but it could also start from the 10th of one month to the 10th of the next month, and so on. A billing cycle is usually between 25 and 31 days, but it can be longer or shorter depending on the card and provider. If you don’t know when your billing cycle is, ask your provider or check your card statement.
Decide how much to pay. When you receive your bill — called your credit card statement — it’s time to decide what to pay. After each billing cycle, your card provider will typically give you a grace period to pay off your purchases where you won’t be charged interest. If you pay your entire balance within this period — i.e., by the specified due date — you won’t be charged any interest. To avoid paying unnecessary interest, it’s a good idea to pay your entire balance. But you can also choose to pay the minimum amount possible or some amount in between. The amount you pay will affect how much interest you owe. You don’t have to wait for your bill to arrive before repaying your bank. If you’d like, you can pay off your balance immediately.
If you pay less than your full balance by the due date, your remaining balance will accumulate interest at the applicable interest rate.
Unfortunately, no. At the very least, you need to make the minimum payment, typically 1% to 3% of what you owe. It’s often wise to pay more than the minimum payment. Be careful about carrying a balance on your card, which could cause your credit card debt to snowball.
Interest is charged as an APR, or annual percentage rate. For example, your card might have an APR on purchases of 20%. Regardless of your card’s APR, it’s a good idea to avoid interest whenever possible. Check out our guide to learn how credit card interest works.
Wait for updates to your credit report. As you make payments on your card, your provider will report your payment history to the credit bureaus. Shortly after your payment due date, the bureaus will update your reported balances and you may see a change in your credit score.
How are credit cards different from other cards?
With a credit card, you are borrowing money that you’ll pay back later. Here’s how it differs from other types of payment cards:
Debit card. The primary function of a debit card isn’t to borrow money. Instead, you use a debit card to spend money you already have in a chequing or savings account. It may be branded as either a Visa debit or Mastercard debit card which allows you to make debit purchases online without entering your PIN number.
Charge card. With a charge card you are still borrowing money when you use it, just like a credit card, but you must pay your balance in full each month. You cannot make just a minimum payment. This is different than a credit card, which lets you carry a balance from month to month.
Types of credit cards
There’s a universe of credit cards out there, and it can be fun searching for your ideal pick. Here are the different card types you’ll find on the market.
A credit repair card can help you re-build your credit history or build it from scratch if you don’t have any. It is relatively easy to get. It won’t offer top-notch rewards, but it does let you build or rebuild your credit slowly.
Secured. You’ll need to put down a security deposit to open a secured card. That deposit becomes your line of credit which you borrow against.
Prepaid. Before you can use a prepaid card, you pre-load it with funds. You can reload it with funds at any time.
Specialty credit cards
Business. With a business credit card, you’ll typically get points, miles or cash back on business-related expenses plus travel benefits and perks.
Student. A great choice if you’re a post-secondary student, student credit cards are designed for students with little or no credit history.
Store. You can use store branded cards only at select retail locations or websites, but you’ll get discounts and rewards when you do. These cards promote loyalty to a specific store.