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Key takeaways
- A credit card lets you borrow money from an issuer to make purchases.
- Paying your statement balance in full by the due date helps you avoid paying credit card interest.
- Responsible use, like making on-time payments and keeping your credit card balance low, can help you build a positive credit history.
- Understanding key terms like your credit limit, APR, and minimum payment can help you manage your card wisely.
A credit card is a type of revolving credit that lets you borrow money up to a certain limit. Credit cards offer a convenient way to shop, manage bills, earn rewards, and build your credit score. When used responsibly, they can be a helpful addition to your financial toolkit.
Understanding how credit cards work helps you use them wisely and avoid racking up high-interest credit card debt. Here’s what you need to know.
What is a credit card, and how does it work?
A credit card is a financial tool that lets you borrow money from a financial institution or a credit card issuer to make purchases in stores and online. You must then repay the borrowed amount, along with any interest or fees charged.
While debit card purchases are covered by the money in your checking account, credit card purchases are made with borrowed funds from a credit card company. Using your credit card is like taking out a small loan that you pay back later.
Here are some terms you need to know:
- Your credit limit is the maximum amount you’re approved to spend on your credit card.
- Available credit is the difference between your credit limit and your current balance.
- A billing cycle is the period between when you make purchases and when you receive your statement.
- The minimum payment is the amount you must pay by the statement due date to keep your account in good standing.
- The interest rate is the amount you pay to borrow money from the credit card issuer.
- Credit cards typically have a grace period – the time between the end of the billing cycle and your payment due date. You can avoid interest on a credit card by paying your balance in full within each grace period.
- APR stands for annual percentage rate and includes the interest rate and any fees for a holistic picture of your total costs.
- Some credit cards offer rewards and benefits, like cash back or points on eligible purchases, that you can redeem for statement credits, gift cards, travel, and more.
Understanding your credit card statement and payments
Each month, your credit card issuer will send you a statement that outlines your transactions, payments, previous balance, new balance, minimum payment amount, and due date. Understanding the following terms will help you read your credit card statement correctly.
Current balance
Your current balance is the real-time balance on your credit card, including the statement balance and any new purchases you made after the billing cycle ended. It can change throughout the month as you make additional purchases or payments.
Minimum payment
Your credit card statement includes your minimum payment – the smallest amount you must pay by the due date to keep your credit card account in good standing. If you only pay the minimum, you’ll avoid late fees but will be charged interest.
Available credit
Your statement will also show your current available credit. When you make a purchase, your available credit decreases. Conversely, when you make a payment, your available credit increases.
Statement balance
Your statement will include a balance of the total amount you owe on your credit card at the end of the billing cycle. Your statement balance includes all purchases, cash advances, balance transfers, fees, and any interest charges applied during that period.
Common credit card fees to watch out for
Credit cards often have various fees in addition to the interest rate. Below are some common credit card fees to be mindful of:
| Fee type | Description |
|---|---|
| Interest fees | Fee for carrying an unpaid balance |
| Annual fees | Yearly fee for being a cardholder |
| Balance transfer fees | Fee for transferring your balance to another credit card |
| Over-limit fees | Fee for spending more than your available credit limit |
| Late fees | Fee for failing to make the minimum payment by the due date |
| Cash advance fees | Fee for withdrawing cash against your credit limit |
| Foreign transaction fees | Fee for using your credit card in another country |
Different cards have different types of fees, so it’s important to review the agreement guidelines to avoid unexpected fees.
Types of credit cards
There are various types of credit cards available. Below are some of the most common:
- Secured credit cards require a cash deposit upon opening. That deposit becomes the credit limit. These cards are designed for people with limited or poor credit histories and offer the opportunity to establish or rebuild credit.
- Rewards cards offer incentives in the form of points, miles, or cash back. These credit card rewards can be earned based on your spending in specific categories such as travel, dining, or groceries.
- Cash back cards provide a percentage of your purchases as cash-back rewards. These cards allow you to earn money back on your everyday spending.
- Student credit cards are tailored specifically for students who are new to credit. They often have lower credit limits and may come with benefits like rewards or educational resources.
Pros and cons of credit cards
Credit cards offer convenience, perks, and the potential to build credit. However, they also carry the risk of debt and fees, and can negatively impact your credit score if not managed properly.
Here are the pros and cons of using a credit card.
Pros of credit cards
- Credit cards can be valuable tools for building your credit. Good credit can make you eligible for car loans, mortgages, and even rental agreements.
- Various credit cards offer rewards programs, from travel discounts and airline miles to cash-back for spending in a certain category.
- Credit cards often come with built-in security protections that safeguard you from unauthorized transactions or fraud.
Cons of credit cards
- Misusing a credit card can hurt your credit score and affect your ability to borrow in the future.
- Some credit cards come with high interest charges if you don’t pay off your balance in full each month.
- Credit card usage can lead to overspending and debt. Credit card debt is typically high-interest and can be hard to pay off.
How to choose the right credit card for you
There are thousands of credit cards on the market, so finding the best one for you can be daunting. Consider these factors when comparing credit cards:
- Low APR: To minimize interest costs, shop for credit cards with a low APR on outstanding balances.
- Promotional APR terms and conditions: Many credit cards offer an introductory period with a 0% APR, but only for a limited time. Check the promotional APR rate terms to understand how long it lasts.
- APR for balance transfers and cash advances: If you intend to transfer balances from other credit cards or use your credit card for cash advances, be aware of the associated interest rates and fees.
- Terms and fees: Review any annual fees, late payment fees, foreign transaction fees, or other charges that may impact the cost of using the card.
- Rewards programs: Different cards can provide cash back, points, or miles based on your spending in specific categories. Consider how you’ll use your credit card and find a rewards program that aligns with your goals.
Check your credit score to determine which credit cards you might qualify for. If you’re new to using credit, it’ll be easier to get approved for a secured card than a premium travel rewards card.
Use credit cards to your advantage
For many people, the benefits of using a credit card outweigh the drawbacks. As long as you pay your bill on time and avoid carrying a balance, using credit cards can help you build credit, get rewards or cash back, and handle expenses with ease.
Compare some of the best credit cards for building credit to start your journey with success.
Frequently asked questions
How do credit cards impact your credit score?
Using your credit card responsibly by making timely credit card payments and keeping your credit utilization low can help build a strong credit history. However, making late payments and carrying high balances can negatively affect your credit score.
What is the best way to use a credit card?
The best way to use a credit card is to make purchases you can afford and pay off the full balance each month. This helps you avoid high-interest debt and prevents overspending.
When should you get a credit card?
Consider getting a credit card when you have a stable source of income and the discipline to manage credit responsibly. If you understand how credit cards work and can commit to paying off your balance in full each month, a credit card can be a solid financial tool.
When do credit cards charge interest?
Credit cards charge interest when you carry a balance from one billing cycle to the next. If you don’t pay off the full balance by the due date, interest charges will apply to the outstanding amount.
What is the minimum payment on a credit card?
The minimum payment on a credit card represents the smallest amount you must pay by your statement due date to keep your account in good standing. It might be a percentage of your balance or a flat dollar amount, whichever is greater.
How do you get a credit card?
You can apply for a credit card online or in person with a financial institution or credit card issuer. The card issuer will review your credit history and income to determine whether you qualify. If approved, you’ll receive the card and a credit limit.