Credit Card

A credit card allows consumers to make purchases from their available credit limit that they can repay later.

Continue reading to learn more about how credit cards work, how to repay them, and how to choose one that works best for your financial needs.

What is a Credit Card?

Credit cards are a form of revolving credit, meaning you can continuously borrow from a set credit limit, repaying it in full or partially at the end of each billing cycle. As you pay down the balance, the available credit goes back up and can be used again.

Credit card processing involves three key roles:

The Issuer – The financial institution that provides the card itself, sets the credit limit, and handles your monthly payments, including collecting interest or issuing accrued rewards points.
The Network – The company (such as Visa, Mastercard, American Express, etc.) that manages the payment infrastructure, determines what businesses accept your card, and sets any rules or benefits associated with the card.
The Merchant – Any business, like a restaurant or retailer, where you make a purchase. Merchants choose which networks they accept and initiate the transaction by submitting the card details into a POS (Point of Sale) system.¹

All of these roles work together whenever you buy something with a credit card. Any purchases made during the last billing cycle make up what is called a statement balance. Your current balance, on the other hand, is the total amount you owe at any given time, including new and pending purchases made since your last statement closed.

Statement Balance Vs. Current Balance

Type of Balance	Description	Recommendation
Statement Balance	Total bill from last billing cycle. Includes any purchases and fees from that specific period of time. Also includes any past due amounts up until that point.	To avoid paying interest, pay this in full by the due date.
Current Balance	The total of what you owe right now. Includes statement balance in addition to any new purchases or pending charges since the last billing cycle closed.	Pay this to bring your account balance to $0.

How Credit Cards Work

Paying with a credit card is more than just a convenient swipe or tap away to buy things. As outlined above, the transaction authorization flow involves the issuer, the card network, the merchant, and the cardholder. This quick process usually only takes a few seconds between submitting your card for payment and approval of the transaction:

Cardholders provide their card information, either by using it in person or entering it online, to make a purchase.
Merchant’s Point of Sale (POS) system securely sends transaction data to the acquiring bank.
The card network receives an authorization request from the merchant’s acquiring bank, and then forwards the request to the cardholder’s issuing bank.
The issuer checks the card status and available credit, and then either approves or declines the transaction.
A temporary hold then appears on your account as a pending charge if a transaction is authorized. This is to accurately show what is left of your available credit limit and will officially post as a finalized transaction in 1-3 business days.

As you make purchases, the amount is added to your total balance. You can spend up to your credit limit within a given billing cycle, which is usually one month. Most borrowers don’t have to pay off the credit card balance in full each month, but it’s a best practice not to carry a balance if you can or to keep it as low as possible.

The last day of the billing cycle is the statement closing date, where your card issuer calculates your spending for the month to put together your statement balance.

A grace period for a credit card is the period between your statement closing date and the payment due date, during which you can avoid interest charges by paying your statement balance in full.² If you don’t pay the full statement balance by the due date, interest may be charged on the unpaid portion of the balance.

Depending on the card issuer’s terms, you may also lose your grace period on new purchases until the balance is paid in full. While not required, most credit card companies provide a grace period.

Types of Credit Cards

There are several types of credit cards to choose from, each designed for different spending habits and credit eligibility. Understanding the key differences between the most common types of cards can help you compare the benefits, requirements, and potential drawbacks of each.

Secured Credit Cards – Ideal for borrowers trying to build or improve their credit history.
Rewards and Cash-Back Credit Cards – Ideal for borrowers who want to earn cash back, points, or other rewards for specific purchases.
Specialty Cards – Ideal for borrowers seeking brand-specific rewards or business owners looking for benefits tailored to their business expenses.

Secured Credit Cards

Secured credit cards work like a standard credit card in that they’re a line of credit with a preset credit limit that borrowers can make purchases against and pay back the balance later. The difference with a secured credit card is that the account holder provides a refundable security deposit when they apply for the card.³

The security deposit often determines the credit card’s limit. For example, if a borrower makes a $300 deposit, they may receive a $300 credit limit. However, the issuer ultimately handles the deposit-to-limit relationship and determines if the deposit is an exact or partial match.

Because you provide a security deposit, secured credit cards may be easier to qualify for than more traditional credit cards. This can make them a helpful option for borrowers looking to build their credit.

To get your security deposit back, you would pay off your balance and close the account. Depending on the issuer, you may be able to graduate to an unsecured card after demonstrating responsible credit usage over time. To improve your chances of qualifying for an upgrade, make payments on time, keep your credit utilization low, and pay your statement balances in full.

Rewards and Cash-Back

Rewards and cash back credit cards operate the same as a standard credit card, except that they offer an incentive beyond the line of credit. The appeal of these types of cards is that every time you make an eligible purchase, the card issuer gives you a percentage of what you spent in reward points.

Depending on the card, points can be redeemed for things like flight miles, company-specific gift cards, or cash back as a direct deposit or statement credit.⁴ A statement credit applies the value of your rewards directly into your credit card balance.

If you have one or more rewards credit cards, there are ways you can maximize the benefits by using different cards for different types of purchases. For example, you might use one card for travel expenses and another for everyday shopping, depending on your spending habits and the rewards each card offers.

Specialty Cards

Similar to rewards cards, specialty credit cards also offer benefits with eligible purchases. Specialty credit cards are designed for specific companies and brands. Examples include co-branded cards, private-label store cards, and business credit cards.

Co-branded credit cards are issued in partnership with certain retailers, airlines, or hotel chains and are backed by a major card network such as Visa and Mastercard. Because they are connected to a major network, they can typically be used anywhere the network is accepted. Rewards associated with this type of card usually include airline miles, hotel points, or exclusive discounts.

Private-label credit cards (or store credit cards) are usually only available to use at an issuing retailer’s locations or website. These also offer exclusive discounts specific to that business, as well as promotional financing and loyalty rewards, but these usually have less flexibility than co-branded credit cards.

Business speciality cards are typically used to help separate personal and company expenses. These types of cards also may include perks or rewards tailored to business spending categories, such as shipping, advertising, and office supplies. Therefore, business cards can be a useful option for business owners, freelancers, or employees who regularly make business purchases.

Credit Card Rewards

Credit card rewards can offer an easy way to get money back from your spending habits, but finding the right one for you isn’t always simple. While rewards structures vary by card, they generally fall into two categories: flat rate and category rewards.

Flat-Rate Rewards – Earn the same rewards rate on most eligible purchases, regardless of what you bought or where you bought it from.
Category Rewards – Usually offer a higher rewards rate in specific categories, such as gas, groceries, or certain retailers.⁵

Determining which type of rewards card is best for you usually depends on your spending habits. Often, cardholders like a flat-rate card, while others use multiple cards to maximize rewards.

How To Maximize Value

Many rewards cards come with an annual fee, so it’s important to understand how to maximize their value or break even. To do this, you would compare the value of the card’s rewards, your statement credits, and other benefits against the cost of the fee.⁶

You can also maximize rewards by:

Using cards that match your most common spending categories.
Taking advantage of introductory bonus offers.
Redeeming rewards regularly before they expire, if applicable.

Ultimately, the value of a rewards card depends on how often you use the perks and whether those benefits align with your spending habits. Cards with annual fees often offer valuable rewards, but they may also have stricter approval requirements.

If you are unlikely to use the card’s rewards or benefits enough to offset the fee, a credit card without an annual fee may be a better fit.

Credit Limit and Higher Credit Limits

A credit limit is the maximum amount you are allowed to spend on a credit card. Credit card issuers determine your credit limit based on factors such as your credit history, income, debt-to-income ratio (DTI), and overall credit profile.

Once you reach your credit limit, any additional purchases may be declined. Keeping your balance low may help you maintain a lower credit utilization ratio, which can improve your credit score over time.

If you are looking to increase your credit limit, you may be able to do so through several methods, depending on the issuer:

Requesting a credit increase through the card issuer’s app or by calling them directly.
Updating your annual income information, particularly if it has increased.
Transferring your available credit between cards from the same issuer, if permitted.
Improving your credit score over time.
Informing your issuer of positive changes to your financial situation, such as reducing significant debt.

Along with these tips, it’s important to keep an eye on overspending after receiving a higher credit limit, as increased borrowing can lead to a cycle of debt if not managed responsibly.

Credit Card Payments

The most common way to make credit card payments is online through the issuer’s app or website, or you can also pay by phone, mail, or in person depending on the credit card. Many issuers also offer the option to make automatic payments, which can help make paying more convenient and help you avoid late payments.

The minimum payment is the smallest amount required to keep an account in good standing. While you can choose to make only the minimum payment, any remaining balance will typically start to accrue interest and may take you longer to pay it off.

Paying your full statement balance each billing cycle can help you avoid interest fees and maintain a lower credit utilization ratio.

Late Payment Fee

A late payment fee is a charge triggered by failing to pay at least the minimum amount required by the due date listed on your statement. In addition to the fee, interest may continue accruing on the unpaid balance and any new purchases.

Making a payment after the due date may result in a late fee, but late payments are generally not reported to the credit bureaus until they are at least 30 days past due. Once a payment becomes significantly late (or delinquent), it may negatively impact your credit score. Depending on the card’s terms, repeated late payments may also result in a penalty APR.

A few simple ways to avoid late payments are to set reminders, enroll in autopay, and regularly review your budget.

If you believe the late fee is an error, such as being caused by an unauthorized charge, you may be able to dispute it with your credit card issuer. Here are the steps you can take:

Contact the Issuer – Reach out to your credit card issuer directly and explain why you believe the fee is incorrect. Be prepared to provide your account details, including supporting documentation like payment confirmations or records of unauthorized charges.
Keep Records of the Dispute – Save copies of any documents, emails, or letters related to your dispute. Respond quickly if the issuer requests additional information while they review your claim.
Report to the Credit Bureaus – If the late payment was reported to the credit bureaus and you believe the information is inaccurate, you may also submit a dispute directly with them.⁷

With this in mind, if the late payment is accurate and you’re having trouble making payments, you can contact your credit card issuer to negotiate a payment plan that works better for your situation.

Fees, Cash Advances, and Interest

In addition to interest charges and late fees, credit cards may come with other costs that are important to understand before applying.

Annual Fees – Some credit cards charge a yearly fee in exchange for benefits, such as rewards or other premium features. Often the fee is waived the first year as a perk of being a new applicant.
Authorized User Fee – Adding an authorized user to your card is usually free, but some cards charge for this.
Balance Transfer Fee – These fees are often charged when you transfer a balance to your credit card and may be a good option if the card has a promotional 0% balance transfer interest rate.
Foreign Transaction Fee – If you use a credit card in another country, each purchase may come with a foreign transaction fee. These fees may apply when purchases are made in another currency or through merchants located outside the United States.

Cash Advance Fee

A cash advance fee occurs when you use your credit card to withdraw cash rather than make a purchase. Most issuers charge this fee, and it is often around 3% to 5% of the amount you withdrew.

While credit card cash advances are a quick way to get access to cash, they are often more expensive long-term. In addition to the cash advance fee, bank and ATM fees may apply, and issuers may charge a higher APR than they do for standard purchases.

Alternatives to consider to avoid cash advance fees include:

Building an emergency fund for unexpected expenses.
Applying for a personal installment loan, which may offer a lower interest rate.
Requesting an advance on your paycheck, if available.

Before considering a cash advance, as well as for any credit card or form of borrowing, it’s recommended to compare all the costs and potential fees involved. Depending on your financial situation, other borrowing options may be a better fit for your financial needs.

How Credit Cards Affect Your Credit Score

Using credit cards wisely can help improve your credit score over time. While applying and opening a new credit card may result in a slight reduction in your credit score due to the hard inquiry, responsible credit use can help build and strengthen your credit history in the long run.

Two of the most important factors that influence your credit score are payment history, which accounts for around 35% of your FICO score, and credit utilization, which accounts for about 30%.

Your credit utilization ratio is the amount of available credit you’re currently using divided by your total credit limit. In general, lower credit utilization ratios are viewed favorably by lenders.

To build a positive credit history, follow these recommended tips:

Make your monthly payments on time.
Keep your credit utilization ratio below 30% whenever possible.
Pay your statement balance in full when you can to avoid interest charges.
Remember to monitor your spending and credit reports regularly.

Managing Credit Card Debt

If you’re struggling to manage credit card debt and are unsure where to start, several strategies can help you reduce your balances and regain control of your finances.

Debt Avalanche Method – Focus extra payments on credit card balances with the highest APR first while continuing to make minimum payments on your other accounts.
Balance Transfer – Move high-interest debt to a balance transfer card with a promotional APR offer, such as a 0% introductory APR repayment period. Be sure to review any balance transfer fees and the length of the introductory period before applying.
Debt Consolidation Loan – Try a debt consolidation personal loan to help organize your credit card debt into a single loan, which may offer a lower interest rate or a more manageable repayment structure depending on your credit profile.
Debt Management Plan (DMP) – If credit card debt is becoming difficult to manage, non-profit organizations may be able to connect you with a credit counselor to help negotiate lower interest rates for you and create a repayment plan.

Managing credit card debt can sometimes feel like you’re drowning in debt, but exploring repayment strategies early may help prevent balances from becoming even more difficult to manage. If you’re struggling to keep up with payments, consider seeking guidance from a trusted financial professional.

How To Choose a Card and Compare Credit Card Issuers

With so many credit card options, it’s important to choose the right one for you and your spending habits. When comparing cards, ask yourself how you plan to use the card, what features matter most to you, and what cards you’re most likely to qualify for.

Credit Card Comparison

Here is a quick breakdown of some popular credit card options to compare fees and rewards. However, be sure to check the card issuer’s website to find specific or updated information about any of the cards listed below. Additionally, we recommend researching a card issuer’s reputation and support before applying to any credit card.

CHASE FREEDOM UNLIMITED

Annual Fee: $0
Rewards: 1.5%-5% Cash-back.
Intro Offer: $200.

CAPITAL ONE VENTURE REWARDS CREDIT CARD

Annual Fee: $95
Rewards: 2x-5x mileage points.
Intro Offer: $75,000 miles.

CHASE SAPPHIRE PREFERRED® CARD

Annual Fee: $95
Rewards: 1x-5x points through the Chase Ultimate Rewards card program.
Intro Offer: 75,000 points

BLUE CASH PREFERRED® CARD from AMERICAN EXPRESS

Annual Fee: $95
Rewards: 1%-6% Cash-back.
Intro offer: $300.

WELLS FARGO ACTIVE CASH® CARD

Annual Fee: $0
Rewards: Unlimited 2% cash-back.
Intro offer: $200.

CITI SIMPLICITY® CARD

Annual Fee: $0
Rewards: None.
Intro Offer: None.

Credit Card Eligibility and Prequalification

When determining approval, credit card issuers will take a look at several parts of your financial history. Common factors include credit score, income, and any financial accounts you already have.

If possible, consider completing a credit card prequalification before submitting a formal application. Prequalification allows issuers to review your credit profile and determine if you meet their basic eligibility requirements before you apply.

The benefit of prequalification is that it usually involves a soft inquiry, which doesn’t impact your credit score. This can be a helpful way to compare credit card offers and to see what cards you may qualify for before officially applying.

Keep in mind that prequalification does not guarantee approval. Once you submit an official credit card application, the issuer will typically perform a hard inquiry, which may temporarily affect your score.

Applying and Account Setup

Once you’ve chosen a credit card that fits your financial needs, the next step is to apply. First, gather the information commonly required to prepare for your application:

Personal information, like name, address, and birthday.
Social Security number.
Income information.
Employment status.
Monthly housing payment, such as rent or mortgage.

After submitting your application, the issuer will review your information to determine approval. If needed, you can usually check the status of your application by contacting the issuer directly.

If you’re approved, you’ll receive the card in the mail and then will need to activate it before using. Some issuers provide a virtual card that can be used immediately. If so, consider adding it to your digital wallet for convenience and secure access.

Finally, once your account is set up, review the card’s terms and conditions so you understand any fees, interest rates, and rewards associated with the card. If the option is available, you may also want to enroll in autopay and account alerts to help avoid late or missed payments.

FAQs About Credit Cards

What is a credit card and how does it work?

A credit card is a type of revolving credit that allows you to borrow money up to a predetermined credit limit to make purchases, pay bills, or in some cases, access cash. As you repay the amount borrowed, your available credit is restored. Depending on the card’s terms, you may be charged interest if you carry a balance from one billing cycle to the next.

Does using a credit card build your credit score?

Using a credit card responsibly can help build your credit score over time. Making payments on time, keeping your credit utilization low, and maintaining accounts in good standing can all contribute to a positive credit history. However, missed payments, high balances, and excessive borrowing may negatively affect your credit score.

What is the difference between a credit card and a debit card?

The main difference between a credit card and a debit card is where the money comes from. A credit card allows you to borrow money from the card issuer and repay it later, while a debit card withdraws funds directly from your checking account. Credit cards can help build credit history when used responsibly, while debit card activity is generally not reported to the credit bureaus.

What happens if you don’t pay your credit card bill on time?

If you don’t pay at least the minimum amount due by the payment deadline, you may be charged a late payment fee and interest may continue accruing on unpaid balances. If the payment remains unpaid for an extended period of time, it may be reported to the credit bureaus and negatively impact your credit score. Depending on the card’s terms, repeated late payments may also result in a penalty APR.

Is there a limit to how much you can spend on a credit card?

Yes, credit cards have a credit limit, which is the maximum amount you can borrow on the account at any given time. Credit card issuers determine credit limits based on factors such as income, credit history, debt-to-income ratio, and overall credit profile. Once you reach your credit limit, additional purchases may be declined until you pay down your balance or receive a credit limit increase.

References:

How Do Credit Cards Work? | Investopedia
What is a grace period for a credit card? | CFPB
How Secured Credit Card Deposits Work | Experian
Consumer Financial Protection Circular 2024-07 : Design, marketing, and administration of credit card rewards programs | CFPB
Should you get a flat-rate or bonus-category cash-back card? | The Points Guy
The Ultimate Guide to Offsetting Credit Card Annual Fees | Upgraded Points
Using Credit Cards and Disputing Charges | FTC Consumer Advice
Chase Freedom Unlimited
Capital One Venture Rewards Credit Card
Chase Sapphire Preferred® Card
Blue Cash Preferred® Card from American Express
Wells Fargo Active Cash® Card
Citi Simplicity® Card