Learning about credit cards, and how to use them responsibly, is a great first step toward financial health. So, if you’re wondering, “How do credit cards work, anyway?” here’s a guide to get you up to speed.
What is a credit card?
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 — called interest.
Use credit cards if you want a secure and convenient way to pay. They’re also excellent tools to build your credit score — a three-digit number that represents how reliably you’re expected to pay your debt.
Beware: A credit card isn’t free money, and you’re always expected to pay back whatever you borrow. There will also be a maximum you can borrow at a time.
How do credit cards work?
Here’s the lowdown on how credit cards work. Once you understand the mechanics behind your card, you’re on your way to using it responsibly.
Credit card mechanics
Swiping your credit card means that you’ll repay your bank later for your purchases. But when do you have to pay?
To find out, you need to know how long your bank’s billing cycle is. After each cycle, your bank will collect all the transactions you’ve made and send you a bill.
A billing cycle doesn’t necessarily line up with each month. It can start from the 1st to the 30th, but it could also start from the 25th of one month to the 25th of the next month, and so on.
To know for sure how long your billing cycle is, ask your card provider. You’ll also see how long the cycle is once you receive your bill.
When you receive your bill — called your credit card statement — it’s time to decide what to pay. 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 decide 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.
How long is a billing cycle?
A billing cycle is usually between 25 and 31 days, but it can be longer or shorter depending on the card or provider.
What is a balance and credit card statement?
A credit card statement is a summary of all the transactions you’ve made on your card over the last billing cycle. It’ll show information like how much you owe to your card provider, the minimum amount you can pay and potential late fees.
Your balance is the amount of money you owe to your credit card provider.
How does interest work?
Many people shy away from credit cards because they’re worried about interest. Interest is money you pay to your bank as a fee for borrowing money or delaying payment on your purchases. In short, it’s a charge for the privilege of borrowing money.
However, you won’t owe interest if you pay your bill in full within a certain amount of time. Your card provider will typically give you a grace period to pay off your purchases. If you pay your entire balance within this period, you won’t be charged interest.
If you pay less than your full balance by the due date, your remaining balance will accumulate interest. At the very least, you need to repay the minimum payment, typically 1% to 3% of what you owe. Be careful about carrying a balance on your card, which could cause your credit card debt to snowball.
How long is a credit card grace period?
Credit card grace periods usually last between 21 and 25 days. Per the Credit CARD Act of 2009, a grace period must be at least 21 days if a provider offers one.
Card issuers don’t have to offer grace periods, but the vast majority do.
Many providers charge an annual fee to use their credit card — a fee you have to pay once a year to remain a cardholder. Annual fees can eat into rewards you might earn, so factor them in when looking for a card.
You may see an introductory annual fee for the first year. This means you’ll pay a discounted fee for the first year and then the stated annual fee every year thereafter.
Keep an eye out for other fees that could include:
Balance transfer fee. For moving your existing credit card debt to your new card.
Cash advance fee. For using your card to collect cash.
Foreign transaction fee. For using your card outside the US.
Late payment fee. For paying at least your minimum after your statement due date.
Returned payment fee. For sending a payment that bounces — for instance, if you enter your checking account number incorrectly.
Returned check fee. For paying with a check that’s returned due to insufficient funds or a closed account.
A credit card offers revolving credit, which you can think of like a rechargeable battery.
Here’s an example: Let’s say your card has a $1,000 credit limit and you make a $400 purchase. That means you have $1,000 less $400 — or $600 — in available credit. At this point, you can spend only $600 more on your card before you hit your limit.
However, let’s say you now pay $300 toward your balance. This raises your available credit to $900 ($600 plus $300). Now you can spend up to $900 on your card. In a sense, you’ve “recharged” your card’s spending power.
Credit cards are different from non-revolving credit sources, which don’t offer more credit after they’re paid off. Home loans and car loans are a few examples.
While browsing credit cards, you may run into the fabled charge card. With this type of card, you’re required to pay your balance in full each month.
Today, only a handful of card providers, such as Brex, offer charge cards to business.
Charge card. With a charge card, you must pay your balance in full each month. This is different than a credit card, which lets you carry a balance from month to month.
ATM card. This is a card you use at ATMs — such as for withdrawals and deposits, and to check your balance. While you can withdraw money with a credit card, this counts as a cash advance that usually comes with high fees and interest rates.
Some basic cards may carry this feature, though you’re more likely to find this on a dedicated balance transfer card.
The pros and cons of a basic credit card
Cheaper to maintain. You will be saving money immediately with no annual fees.
Lower interest fees. Interest fees can represent the largest cost when it comes to credit cards, so having a card with low or no interest fees can translate into substantial cost savings.
Less temptation to spend. Having a lower reward earning means you won’t be tempted to spend unnecessarily.
Less possible debt. If you have a lower interest rate on purchases, you’re more likely to be able to repay your balance in full and avoid falling into debt.
Limited extra features. If you’re after premium perks, such as lounge access, companion certificate or travel credit, a basic credit card might fall short.
Less value. Depending on what sort of spender and cardholder you are, you may find that basic credit cards offer less value in terms of features and privileges. For example, if you are a big spender and frequent traveler who always pays off your monthly account balance in full, you’ll probably get more value from using a premium airline credit card even if it has an annual fee.
Less available credit. Although it’s not always the case, basic credit cards tend to have lower credit card limits than premium cards.
You’ll typically see a credit card’s interest rate expressed as an APR, short for annual percentage rate. This makes it easier to compare interest rates between cards.
Some cards offer an introductory APR. An intro APR means you’ll receive a special APR for a specified period of time, after which your APR will increase. For example, you may get a 0% intro purchase APR for 12 months, after which your APR will revert to 20%. To avoid accruing interest, pay off your balances before the 12 months are up.
Fixed vs. variable interest rates
A fixed interest rate stays the same for the entire time you have your credit card. You won’t find many fixed-rate cards, because the Credit CARD Act of 2009 made it more difficult for card providers to change interest rates at will. Essentially, it became more difficult for providers to advertise fixed rates and hike APRs later.
You’re much more likely to find a card with a variable interest rate. This means your APR is typically pegged to the prime rate — the interest rate banks give to those they consider most creditworthy. Your provider will usually use the prime rate plus a certain percentage to determine your APR.
To figure out your interest rate, you can keep track of the prime rate published by The Wall Street Journal. Alternatively, periodically ask your card provider what your APR is.
You may also see something called deferred interest. This is interest you won’t have to pay if you pay off a purchase within a specified period of time.
Some cards come with an introductory balance transfer rate. With this intro rate, you’ll get a lower APR on your transfer for a specified amount of time, after which your APR reverts to the usual balance transfer rate. To avoid accruing interest, pay off your balances before your intro APR expires.
Balance transfers usually come with fees — typically a flat rate or a percentage of each transfer, whichever is the higher fee. Also, they might not be subject to the grace periods you get with purchases.
When you get a cash advance, you use your credit card to take out cash. For example, you might use your card at an ATM. Purchases like gambling chips, gift cards or traveler’s checks may be classified as cash advances.
It’s a good idea to avoid cash advances because they tend to attract high APRs and fees. Also, they often don’t come with grace periods for interest.
Credit utilization ratio
Your credit utilization ratio is how much you owe on your credit cards compared with your total credit limits.
Say you have three credit cards with different credit limits: $1,000, $2,000 and $3,000. This means you have $6,000 in total credit.
You carry a $1,000 balance on your first card and a $2,000 balance on your second card. You carry no balance on your third card. In total, you carry a $3,000 balance across all of your cards.
Overall, you have a $3,000 balance and $6,000 in total credit. So your credit utilization is $3,000 divided by $6,000 — or 50%. If you had a $2,000 total balance, your credit utilization would be $2,000 divided by $6,000 — or 33%. And so on.
A credit card is offered by a bank — Bank of America, for example. But if that’s so, why does your card include a logo for Visa or Mastercard?
It’s because credit cards are supported by both issuers and networks.
An issuer is a bank or credit union that distributes credit cards. You borrow money from your issuer when you swipe your card. Examples of issuers include Bank of America, Citibank, Chase and the State Department Federal Credit Union.
Your issuer is the one you’ll make payments to and call if you have problems with your card. You’ll probably contact your card network more infrequently — for example, when you want to take advantage of benefits such as Visa Concierge or Mastercard roadside assistance.
When you apply for credit from a lender — for a mortgage, car loan or credit card — your credit score matters. Your credit score is a numerical measurement of how trustworthy you are as a borrower. Lenders check your credit score to gauge their chances of being repaid. Here’s a simple rule of thumb: The higher your credit score, the more likely you’ll be approved for a credit card.
Many organizations calculate credit scores, but the go-to source is a company called FICO. You can use recommended credit scores for cards to help you determine which credit card best fits your financial situation. Here are a few important factors that affect your credit score and, in turn, your approval odds:
Credit utilization ratio. This is the amount of credit you’re using relative to your total available credit. Lenders want to see low credit utilization — it implies you manage debt responsibly and are unlikely to default on your payments.
Payment history. One of the best ways lenders can predict whether you’ll make payments on time is to check whether you’ve already been doing so with other debt.
Length of credit history. Card providers can more accurately predict how reliably you’ll make payments if you have a long credit history.
How does a credit card affect your credit score?
When you apply for a credit card, your provider will check your credit in a hard pull. This will typically lower your credit score by a few points. But this is usually not too much to worry about, as you can regain those points within a relatively short period of time.
Having a credit card can impact your credit score in bigger ways. Two of the most important factors here are your record of making card payments on time and how much debt you carry on your cards.
What is the range of FICO scores?
The lowest FICO score is 300, while the highest is 850. The higher your score, the more trustworthy a borrower you appear to a lender.
Depending on your score, you’re said to have excellent, good, fair or poor credit:
Excellent — 740 to 850
Good — 670 to 739
Fair — 580 to 669
Poor — 300 to 579
You’ll qualify for different credit cards depending on your credit score.
What types of credit cards are suitable for beginners?
These types of products are excellent picks for a first-time credit card:
No-annual-fee cards. While you’re learning the ropes of credit cards, it’s helpful not to have to pay an annual fee. You can use your card as much or as little as you want, without paying to maintain it.
Secured cards. This is a strong option if you don’t have a credit score yet. Because you must put down a security deposit, more lenders will be willing to accept you as a customer. As you slowly build your credit score, you can apply for better cards.
Student cards. An excellent choice if you’re currently enrolled in college. Providers are often willing to approve you even if you’re new to credit.
Here are a few reasons it might be advantageous to get a credit card:
Build or rebuild your credit. A credit card isn’t the only way to build credit, but it’s an excellent choice. When you use your card and consistently pay your bills on time, your credit score will increase. It’s a great idea to start as soon as you feel ready to build credit.
It’s a more convenient way to pay. Instead of carrying a lot of cash or writing checks, you can simply swipe your card.
Make a large purchase and pay it off over time. If this is your primary reason for getting a credit card, consider whether the purchase is essential. Also, make sure you can pay off your purchase in good time.
Earn rewards. As you spend with your credit card, you may earn cash back that you can redeem for bank deposits or statement credit. Or you may earn points or miles that you can redeem for travel, gift cards and more.
Make safer payments. With a credit card, money leaves your bank account only when you pay your statement. Because of this, a credit card could be more secure than a debit card. With a debit card, money is deducted from your account right away.
When you shouldn’t get a credit card
Consider holding off on a credit card if you:
Have difficulty controlling spending. If you habitually overspend, consider holding off on a credit card. You may rack up huge amounts of debt that will be difficult to repay. Work on solving your spending problem, or stick to debit cards.
Can’t pay larger amounts toward your monthly balances. The longer you carry a balance, the more interest you’ll accumulate. Interest can be surprisingly expensive in the long run.
Don’t have the right credit score.Find out what your credit score is before applying for a card. It’s certainly no fun getting denied. Also, applying for many cards can significantly affect your credit score.
What is the cost of owning a credit card?
Owning a credit card isn’t always free. There are several costs to watch out for, from the well-advertised to the non-obvious.
Fees. The annual fee is typically the cost you see first. It commonly ranges from $0 to $550, but it can reach the $1,000 range and beyond. You’ll also want to avoid foreign transaction fees, cash advance fees, overlimit fees and the like.
Interest. If you don’t pay off your balance by the end of your card’s grace period, you’ll start accruing interest. Interest can snowball faster than you think, so consider paying your bill in full each billing cycle.
Changes to your creditscore. If you keep high balances on your credit cards — or, worse, miss payments — your credit score will drop. This, in turn, will result in higher interest rates when you’re ready to apply for loans. Over the long run, this can cost a lot.
How to choose a credit card
With so many credit cards on the market, there’s no “perfect” card. Here are a few factors to compare to help you decide.
Consider whether you’re willing to pay an annual fee for your card. If you’re not, there are plenty of no-annual-fee products to choose from.
Also, consider the things you’re likely to do with your card, and avoid the corresponding fees. For example, if you’ll use your card internationally, look for a product with no foreign transaction fees.
Before applying for a card, check its pricing and terms. There, you’ll find the interest rates you’ll pay for various transaction types. The APR is especially important if you plan on carrying a balance from month to month.
It’s best to get a credit card only if you have your finances in order. If you have structural financial problems like chronic overspending, a credit card won’t help — instead, it could make things worse.
It’s easy to rack up large balances on credit cards, especially because most cards don’t require you to pay your bill in full each month. Paying the minimum each month is a particularly good way to find yourself deep in debt.
Beyond considering whether you can spend responsibly, think about how a card can help you reach your financial goals. Maybe you need to make a big purchase and pay it off over time. In that case, a 0% APR card could be a better choice. If you need to escape from high interest rates on your current card, you could apply for a balance transfer card.
Your credit history
Your credit history will largely determine which credit cards you’ll qualify for. The higher your credit score, the more choices you’ll have.
If you have a good or excellent credit score of 680 or higher, you could qualify for rewards cards, often considered the best credit cards available.
It will be tougher to get a credit card with fair credit, but you do have options. However, it’s unlikely that you’ll get a card that offers rewards.
Income is a significant factor when a card provider decides whether to approve you. The reason is simple: Your provider wants to know you have the ability to repay your debt. All else being equal, the higher your income, the more likely your provider is to approve you.
You don’t necessarily have to be employed to get a credit card. As long as you have some source of income, you’re eligible.
Your personal interests
You can find a card that complements your interests. For example, if you like staying at a certain hotel chain, you can get a card that rewards you for spending money there.
When you apply for a credit card, your card provider may need copies of your latest pay stubs to verify your income. They may also ask for documents to verify your identity.
While most providers require you to apply for a credit card in your own name, some will let you apply for a joint account with a partner. If you want to give others access to your account, add them as authorized users.
We’ve assembled a few common application requirements you can expect when applying for a credit card.
Minimum income. This is how much you need to earn every year to be eligible for a card. Overall income requirements vary by providers — for example, American Express tends to require higher incomes for approval. But you may be able to gauge your chances by calculating your debt-to-income ratio.
Age. To be approved for nearly all credit cards, you must be at least 18 years old.
Good credit history. Typically, you must have good credit and no active defaults to be eligible for a card. If you haven’t yet established a credit history, you may only be eligible for a low credit limit. By using your card responsibly, you’ll build your credit until eventually, you can apply for a limit increase.
Personal information. This includes your name and date of birth.
Contact details. You’ll be asked for your email address, phone number and residential address.
Financial information. Your employment status, annual income, and monthly rent or mortgage payment. Sometimes, you’ll need to provide copies of your most recent pay stubs to prove your income. If you’re self-employed, you may need to provide your tax return.
What happens after I apply for a credit card?
In some cases, you’ll receive immediate approval. If your provider needs to review your application, wait two weeks to hear back. If you still haven’t heard from your bank after that time, contact a representative and ask about your application.
Upon approval, look for your card in the mail within seven to 10 business days. Then follow the enclosed instructions to activate your card.In some cases, an issuer may provide your credit card account number immediately upon approval. If so, you can use that information to start your spending.
Congratulations — you’re ready to start using your first credit card!
How long do credit cards last?
There’s no penalty for keeping a credit card for a long period of time, even if you aren’t actively using the credit card. In fact, closing a credit card you own can do more to hurt your credit score than help. Even an unused credit card contributes to your credit utilization – getting rid of that unused card can result in a sudden boost to your utilization score.
With that said, there are a few reasons you might want to cancel an existing credit card:
The card has an annual fee. If a credit card you own has an annual fee but you rarely use the card for purchases, you might consider canceling that card to avoid paying needless fees.
You have too many cards. If you find yourself unable to juggle a large number of credit cards that you might have accrued over time, such as store cards or other specialized credit cards, you might consider canceling a few. Better to ease your mental financial load than to accidentally miss payments or other credit card fees you’ve forgotten about.
You want to upgrade. Sometimes, you simply want to replace an existing credit card with a better one. If you aren’t changing products within the same issuer, you’ll probably want to cancel the outdated card that you’re replacing. Consider balancing your payments and spending on the new card before canceling to help stabilize your utilization.
It’s a great feeling when you finally get your first credit card. When you do, resolve to build good financial habits.
Keep your spending in check, pay off your balance in full each month and avoid these other credit card mistakes. These are the keys to using a credit card like a pro, building your credit score and opening new financial opportunities.
If you still have questions about credit cards, reach out to us using the form at the bottom of this page. A member of our team will be in touch.
Kevin Joey Chen is a credit cards, banking and investments writer whose work and analysis have appeared on CNN, U.S. News & World Report, Business.com, Lifehacker and CreditCards.com. He's passionate about helping you get your finances in order by expertly navigating cutting-edge financial tools — including credit cards, apps and budgeting software.
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