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How credit cards work

A credit card is an unsecured revolving line of credit, which basically means you can borrow money to make purchases without having to put up collateral (upfront cash). Based on your perceived ability to make repayments, credit card companies assign a credit limit, which is the maximum amount of money you can borrow.

Unlike a debit card that uses your own money to make purchases, when you use a credit card, it is the lender who pays the retailer. At the end of your billing cycle, you receive a statement and that tells you the total amount you owe the lender for that period. Credit card companies make money on fees and the interest that accrues on your revolving credit.

There are many types of credit cards depending on the type of user. They range from general-purpose cards issued by big banks, to secured cards for people with poor credit, to co-branded store credit cards incentivizing you to keep shopping at Walmart or Amazon.

Credit card companies have been offering increasingly shiny rewards, sign-up bonuses, and travel perks to lure new users to spend with them. This is great if you pay your bills on time and in full. If you don’t, you offset any rewards gained by paying fees and interest For those using credit cards because money is tight, If you don’t, you will end up paying

Beginner’s guide to credit cards

What cards are you looking for?

Rewards

Travel

Secured

Balance Transfer

Business

Debit

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How credit card interest works

Understanding APR

As you spend on your credit card, your debts will also begin to collect interest if you’re unable to pay the whole balance back by the end of the statement or interest-free period. If you’ve used your card for purchases, it will start collecting interest charge. This is called an APR, or annual percentage rate, and it usually hovers between 11.99% and 20%. If you’ve used your card for an ATM withdrawal or any other transaction that’s considered a cash advance, you’ll accrue the cash advance rate of up to around 22%.

If you decide to transfer your debt from one card to another — maybe another card offers a better APR — you’ll also accrue a balance transfer interest rate, which is usually the same as either the interest rate or cash advance rate. Some cards do offer 0% promotional periods on purchases and balance transfers, so this is something to keep in mind during your comparison.

Each month, you’ll receive a statement that will detail the transactions you’ve made, the total outstanding balance you have and any interest you’re accruing. While you’re only required to pay a minimum repayment each month (2-3% of your total balance), it’s best to pay as much as you can. If you pay your entire balance in full, you can usually take advantage of up to 55 interest-free days in the next statement period. If you don’t pay your entire balance in full, the remainder will start to collect interest. If you miss the minimum repayment, you could be charged late payment fees.

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Comparing credit card features

What are the costs of a credit card?

• Repayments. You’re free to repay as much as you like as often as you like. You’re required to make the minimum repayment when your statement is issued. The minimum repayment is usually 2% of your outstanding balance. You will pay a late payment fee if you don’t make the minimum repayment by the statement due date.
• Annual fee. This is the cost to own a credit card. The annual fee ranges from $0 to hundreds of dollars depending on the credit card type. The credit card annual fee is deducted from your available credit and accrues interest at the purchase rate if it isn’t paid in the first statement period.
• Interest rates. Interest is the price you pay to borrow money. Credit card interest rates are much higher than other types of finance because credit cards are an unsecured product; financial institutions have no recourse to take your assets if you default on your repayments.
• Other fees. Other fees you may run into include late payment fees, overlimit fees (a fee for spending past your credit limit), rewards program membership fees and cash advance fees.

Credit card application tips

While applying for a credit card doesn’t have to be complicated, it can come with certain risks.

1. Assess your needs. Before you begin your search, spend some time considering what you want, need and can afford with your next credit card.
2. Compare your options. Once you’ve decided what type of card you want, it’s time to begin comparing your options.
3. Are you eligible? Know the requirements for the card application – do you need a minimum income, and do you meet the age limit?
4. Know your credit score. You should request a free copy of your credit history before applying, so you can correct any possible errors on it and see exactly what the bank will be seeing when they assess your application.
5. Lower your credit utilization ratio. If you already have a credit card balance, it’s wise to pay off your existing balances before submitting a new credit card application.
6. Don’t apply for multiple cards at once or within a short period. You may be tempted to apply for a second card just in case your first one doesn’t get approved, but don’t. Each credit enquiry that a lender makes about your credit history leaves a new mark on your credit file for five years.

Complete list of credit card application tips

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Understanding your credit score

It may sound counterintuitive, but sometimes taking on debt can actually strengthen your financial future. If you’ve ever taken out a student loan, applied for or owned a credit card, or opened up a bank account in your name, you have a credit score. Your credit score is calculated by a credit bureau, and they are observing how responsibly you have handled your loans and your debt.

The three major credit bureaus — Equifax, Experian and TransUnion — use a set of factors and complex equations to determine your score. This is important, because your score is often used by lenders to help decide whether to approve you for new credit cards, personal loans and home loans. For example, your Equifax Score is a number between 300 and 850. The higher your number is, the better your credit position is.

Guide to understanding your credit score

What's a good credit score?

What's a credit utilization ratio?

How my score dropped 60 points