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How do credit cards work? A beginner’s guide (2019)
Learn the basics of credit cards — and how to choose your first one.
Once you get the hang of them, you’ll find that credit cards are incredibly helpful financial tools. If you’ve been wondering, “How do credit cards work, anyway?” here’s a guide to get you up to speed.
What's in this guide?
- What is a credit card?
- How do credit cards work?
- How are credit cards different from other cards?
- Types of credit cards
- Compare the most common credit cards
- Credit card terms you should know
- Credit cards and credit scores
- What types of credit cards are suitable for beginners?
- Do I need a credit card?
- What is the cost of owning a credit card?
- How to choose a credit card
- How to apply for your first credit card
- What happens after I apply for a credit card?
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?
Once you understand the mechanics behind your card, you’re on your way to using it responsibly. You can also learn more about credit card features.
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 often have this fee, but you’ll find many great cards without it.
You may see an introductory annual fee for the first 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 seven to 10 business days.Once you’re approved, your provider will open your card account and send you a physical card within seven to 10 business days.
Make purchases with your card.
You can spend with your card by swiping it on a card reader. If your card has a chip, you’ll “dip” it into the card reader. 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 balance — the amount you’ve borrowed on your card but 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 opt in for your card provider to allow charges over your credit limit. However, you’ll typically be penalized with a $25 to $39 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 repay your bank 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, but it could also start from the 25th of one month to the 25th 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. If you pay your entire balance within this period — i.e., by the specified due date — you won’t be charged 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.
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.
- Apply for a credit card.
How are credit cards different from other cards?
With a credit card, you essentially borrow money that you’ll pay back to your bank later. Here’s how it differs from other types of payment cards:
The primary function of a debit card isn’t to borrow money. Instead, you use it to spend money you already have in a checking account.
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.
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.
- Debit card.
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.
Different types of credit cards
Standard credit cards
- Low interest. This type of card can offer a low interest rate forever or a very low interest rate at the beginning that reverts to a higher rate later.
- Balance transfer. With a balance transfer, you move your existing credit card debt to another card. A balance transfer card gives you a low interest rate when you move your debt.
Rewards credit cards
Rewards cards provide bonuses for your everyday spending.
Credit repair cards
A credit repair card is relatively easy to get. It won’t offer top-notch rewards, but it does let you build or rebuild your credit slowly.
Specialty credit cards
- Business. With this card type, you’ll typically get points, miles or cash back on business-related expenses.
- Student. A great choice if you’re a college student, student credit cards are designed for customers with little or no credit history.
- Store. You can use store cards only at select retail locations or websites, but you’ll get discounts and rewards when you do.
- Gas. Get discounts when you spend on fuel with this card.
- Charge. You’re required to pay your balance in full each month. American Express is the only major US provider that offers them these days.
Compare the most common credit cards
Credit card terms you should know
Here are a few important terms you should know while you look for a credit card. For more information, review the full credit card glossary.
Credit card terms
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.
The Best Buy Credit Card offers deferred interest on select items.
“Deferred interest” does not mean “zero interest.” If you don’t pay off your purchase in full within the specified time period, you’ll be charged interest starting from the day you swiped your card.
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.
But this is where the magic of revolving credit comes in.
- 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.
Credit card fees
- Annual fee. For remaining a cardholder. This is the cost you’ll pay every card year to own the card.
- 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.
- Overlimit fee. For making a transaction that exceeds your credit limit.
- 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.
- Minimum payment requirement. While not exactly a credit card fee, some merchants have minimum purchase requirements if you want to use your credit card.
Pay attention to the fine print associated with these fees. Failure to do so is how many consumers fall into credit card “traps” and pay the price when it comes to credit health.
When you initiate a balance transfer, you move your existing credit card debt onto a new card. Any debt you move will be subject to your new card’s balance transfer APR.
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.
Your credit utilization factors heavily into your credit score. It’s a good idea to keep it below 30% at all times.
Issuers vs. networks
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.
- A network is a company that processes credit card transactions. The biggest American card networks are Visa, Mastercard, American Express and Discover. In fact, your credit card numbers are directly related to your card network.
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.
Read our guide to learn more about credit card issuers and networks.
Credit cards and credit scores
When you apply for credit from a lender — for a mortgage, car loan or credit card — your credit score matters. Lenders check your credit score to gauge their chances of being repaid.
Your credit score is a numerical measurement of how trustworthy you are as a borrower. 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.
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:
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.
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.
An excellent choice if you’re currently enrolled in college. Providers are often willing to approve you even if you’re new to credit.
- No-annual-fee cards.
Do I need a credit card?
It’s natural to be nervous to apply for a credit card. The truth is, there are good reasons to get a card, as well as situations in which you shouldn’t get one. Here are a few arguments for both, but you can check out our full guide on when to apply if you need more help.
When you should get a credit card
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.
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.
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 credit score.
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. For a more perfect fit, check out our full selection guide.
Comparing credit card factors
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.
If you’ll initiate a balance transfer on your card, you might like a product that waives transfer 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.
Check if the card’s bonus rewards match with your typical spending. If you’re a foodie, for example, you might like a card that offers accelerated rewards on dining purchases.
If your supermarket bills are substantial, look for a grocery credit card.
If you spend relatively evenly across many categories, you might like a card with flat-rate rewards.
Particularly if your card has an annual fee, there will likely be benefits you can enjoy. The best travel cards often have perks like travel credits, airport lounge access and hotel status upgrades.
Your financial situation
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.
If you have poor credit, most cards will be out of reach. Consider a secured credit card to rebuild your credit.
If you’re young, you probably don’t have much of a credit history. Consider starting with a student credit card or secured credit card. Both cards can help you learn how to use credit responsibly.
The older you are, the more likely you are to have a credit history. Check your credit score and apply for the cards that you have a good chance of being approved for.
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.
You’ll also find brand-specific cards. If you like football, for example, you could get the NFL Extra Points Credit Card. Wherever you like to spend money — whether it’s Disneyland, Hot Topic, Costco or Southwest Airlines — see if there’s a card that fits your interests.
How to apply for your first credit card
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.
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.
Congratulations — you’re ready to start using your first credit card!
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 and pay off your balance in full each month. These are the keys to using a credit card like a pro, building your credit score and opening new financial opportunities.
For our best credit card picks of 2019, check out our guide here.
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.
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