Key Takeaways
- Credit cards can be used to digitally pay for goods using a predetermined line of credit.
- Credit cards can be used to build credit, which makes it easier to achieve goals, like taking out a loan or buying a home.
- Credit cards charge interest on the unpaid balance of the account.
- Credit cards may offer rewards like discounts, travel miles, or cash back.
Credit cards are a piece of plastic that can be a real game-changer for managing money. But they could also be stressful if not handled correctly.
So, what’s the secret to using your credit card responsibly? It’s all about understanding what a credit card is and when you should use it.
Let’s learn how credit cards work – from limits and billing cycles to interest and fees – and the process of getting and managing one.
What is a credit card?
A credit card is a physical, plastic card issued by a financial institution that gives you a line of credit.
- With a credit card, you can borrow money up to a predetermined limit.
- When you use your credit card, you borrow money from the card issuer to pay for goods or services.
- The issuer pays the merchant immediately.
- In return, you agree to repay the borrowed amount, either in full by the due date or over time with added interest.
If you pay your balance in full each month, you won’t owe any interest on what you borrowed.
But interest will accrue if you don’t pay off your balance at the end of the month, and there may be additional fees.
How does a credit card work?
A credit card is a type of revolving credit, which means your credit limit goes back up when you pay it off.
When you apply for a credit card, the issuer will review various factors like your credit history, income, and any existing debt. They will use this to determine if you’re a reliable borrower and approve you for a credit limit.
This limit represents the maximum amount you can borrow at any time. Every purchase you make lowers your available credit, and when you repay part or all of your balance, your available credit goes back up.
When do you need to pay your credit card statement?
Credit cards operate on billing cycles – typically lasting about a month.
At the end of each cycle, the issuer sends you a statement with a list of your activity. This statement includes your purchases, payments made, any interest or fees, outstanding balance, minimum payment, and due date. Credit card companies are legally required to send statements at least 21 days before it’s due.¹
If you don’t pay off your balance, the credit card company will apply an annual percentage rate (APR) to the balance, which is added to your next billing statement. This APR is a type of interest rate that is generally compounded daily. There may also be other fees, like annual fees, late payments, and foreign transaction fees.²
Pros and cons of credit cards
Like any financial tool, credit cards have benefits and potential drawbacks. Before applying, it’s important to weigh the pros and cons of credit cards to help you decide if it makes sense to get one.
| Pros | Cons |
|---|---|
| Help you build credit: Responsible use can strengthen your credit score. | Potential high interest rates: Some types of credit cards can have high interest rates, particularly if a balance is carried over time. |
| Convenience: Credit cards are usually accepted at most retailers or stores. | Risk of debt: When it’s easy to spend, you could get into debt. The added interest can make it harder to get out of debt. |
| Security: Credit cards often come with fraud protection and can be more secure than using a debit card, especially if you are traveling abroad. | Fees and penalties: You may be charged fees if you make late payments or exceed your credit limit. |
| Emergency spending: A credit card can be a reliable resource for unexpected expenses if you don’t have enough money in your emergency fund to cover it. | Potential credit damage: Mishandling your account can negatively impact your credit score. |
Types of credit cards
There are different ways and reasons to use credit cards, and some credit cards are designed for specific types of activity. Here are some of the most common types of credit cards:
| Type of credit card | Uses & Benefits |
|---|---|
| Secured credit cards | These types of credit cards function similarly to debit cards, allowing you to determine your own credit limit and use a deposit to make payments and build credit history. Responsible use can help improve your credit so you can upgrade to an unsecured card over time. |
| Unsecured credit cards | Without any deposit requirements, these cards rely on your credit history, income, and other financial factors for approval. They typically offer higher spending limits, enhanced rewards, and lower fees if you have solid credit. |
| Cash back credit cards | Rather than giving you points, cash back credit cards give you back a percentage of your purchases to be redeemed as statement credits, direct deposits, or gift cards. The exact percentage varies depending on the specific card and provider, but typically ranges anywhere from 1% to 5%. |
| Credit cards for building poor credit | Some credit cards can help you build credit if you don’t have any or have very bad credit. For example, student credit cards and store credit cards might be easier to obtain, but can come with higher interest rates and lower credit limits. |
| Store credit cards | Many stores offer store-specific credit cards that can only be used with that specific retailer or its affiliates. These store credit cards often offer exclusive discounts, rewards, or financing deals for purchases made using them. |
| Travel rewards credit cards | A travel rewards credit card earns points or miles on purchases, which can be redeemed for flights, hotels, and other travel expenses. Many of these cards also offer perks like airport lounge access, travel insurance, and no foreign transaction fees. |
What purchases should you use credit cards for?
Credit cards can be used to pay for just about anything. But to avoid getting into too much debt, try to use your credit card for things you normally use and can pay off in full each month, like:
- Groceries
- Gas
- Clothing
- Utility bills
- Home appliances
- Online bills
- Monthly subscriptions
When used wisely, credit cards can help you build your credit history, enhance your credit score, and help your applications for future car loans or mortgages.
Tips for using credit cards responsibly
While a credit card can be useful, it can also lead to debt if you’re not careful about your spending habits. To avoid falling into unnecessary debt, consider these tips:
- Always pay on time: On-time payments help you avoid late fees and can help improve your credit score. Consider setting up auto-payments or reminders so that you don’t end up paying extra.
- Keep your balance low: Maintain a low credit utilization ratio, meaning don’t use too much of your available credit. Ideally, it should be under 30% of your credit limit. This can help you build your credit score because your utilization makes up about 30% of your FICO® credit score.³,⁴
- Regularly monitor your statements: Review your monthly statements to find any unauthorized charges or errors and make sure all your payments are recorded correctly.
- Understand your card’s terms: Read your cardholder agreement and the specifics of your APR, fees, rewards, and any introductory offers.
Get started with a secured credit card
If you’re new to credit cards, the Chime® Credit Builder Secured Visa® Credit Card can help you build credit with on-time payments.⁴
Chime reports positive activity to the major credit bureaus but doesn’t report your credit utilization ratio, making it even easier to build credit safely.
Frequently asked questions
What’s an annual fee?
An annual fee is a yearly charge for holding the card. In return, issuers may offer enhanced benefits like better rewards, travel perks, and additional purchase protections. Often, cards with no annual fee may provide greater value for individuals new to credit.
Are APRs fixed or variable?
Most credit card APRs are variable, meaning they adjust based on an index (typically the prime rate plus a margin). For example, a rate described as “Prime + 12.99%” may change as the prime rate fluctuates. Fixed rates are less common and remain constant despite market shifts.
What's the difference between a credit card and a debit card?
While both cards may look similar, the key differences are:
- Credit cards allow you to borrow up to a set limit, require monthly repayments, help build credit, offer enhanced fraud protection, and often include rewards.
- Debit cards directly access funds from your checking account, do not build credit, and typically include fewer purchase protections and rewards.