Credit cards are a form of revolving credit, which allows borrowers to continuously spend against a credit limit that resets at the end of each billing period. A billing period, or billing cycle, is typically one month in length.
At the end of each billing period, the money the account holder has spent will be added to their total balance. In most situations, borrowers do not have to pay off their credit card balance in full each month. However, to avoid accumulating an overwhelming amount of credit card debt, it’s best practice not to carry a balance or to at least keep it as low as possible.
There are several types of credit cards, including standard credit cards, secured cards, charge cards, and balance transfer cards. While all of these products function similarly, they have core differences that may make one better suited for your financial situation than another.
Here, you will learn how credit cards work, how to find the best card for you, and other important information all consumers should know about revolving lines of credit.
How Does a Credit Card Work?
To utilize a credit card, consumers must apply for an account. Similar to applying for a loan, issuers will take a look at your credit score, income, and financial history when they determine approval. However, many credit cards have much more lenient approval requirements than traditional personal loans, so you can still apply and possibly receive quick approval even with less-than-perfect credit.
Upon approval, you will receive information about your card details, like your credit limit, minimum payments, interest rates, etc. Once you have reviewed your details, you can sign your credit card contract. At that point, your issuer will send you a physical card you can make purchases with.
As you make purchases using your credit, the amount you spend will be added to your total balance. You may spend up to your credit limit within a given billing period. Or, if you have spent your full credit limit within a particular billing period, you may pay off part of that monthly balance to free up room in your credit limit for the month once again. If not, you will have to wait until the end of your billing period for your credit limit to renew.
At the end of each billing period, you will receive a credit card statement that shows information such as your:
- Transaction history.
- Interest rates.
- Monthly balance (the amount of money you have spent within the current billing period).
- Total balance (your combined balance encompassing balances from previous billing cycles).
Repaying a Credit Card
Borrowers can repay their credit cards with minimum payments, partial payments, or full payments.
Minimum Payments
Most credit card accounts come with a minimum payment, meaning borrowers are responsible for paying back a minimum amount each month when they carry a balance. Making minimum payments each month is probably not the most efficient way to clear your credit card balance, especially if you use your card on a regular basis. Instead, you may want to make partial or full payments every month.
Partial Payments
With partial payments, borrowers pay off a portion, but not all, of their total credit card balance. Depending on how high your balance is, a partial payment is usually more than a minimum amount payment. Borrowers may also choose the specific amount of a partial payment they contribute towards their credit card balance, allowing them to pay off their balances in the best way that works for them.
Payments in Full
Lastly, you can pay off your credit card balance in full. Paying off your balance in full means clearing out the entire thing, making your monthly balance and total balance both equal $0. Paying off your credit card balance in full each month is the most responsible way to use a credit card because you may benefit from your available credit limit without acquiring debt.
Types of Credit Card Transactions
There are several types of transactions borrowers can make when using a credit card.
Standard Credit Purchases
Making everyday purchases using your approved credit line is the most common transaction someone typically makes using their credit card. The transaction process will work similarly to using a debit card, except the funds come from your approved credit limit rather than your checking account.
Statement Credit
Statement credits are funds that are credited to your account by your issuer. A credit card holder may receive a statement credit if they return an item they purchased using their credit card or if there was some kind of mistake and funds were deducted from their credit card account mistakenly.
Cash Advances
You may also take out cash using the credit limit from your credit card account. The process for getting cash back with a credit card works similarly as it would with your debit card. Simply visit an ATM and request funds. Most of the time, unless their approved credit limit is lower, borrowers usually have a cash-back withdrawal limit of $1,000.
Types of Credit Cards
There are several types of credit cards consumers may utilize.
Standard Credit Card
A standard credit card is a line of credit with a preset credit limit. Borrowers can make purchases against their credit limit and pay back the balance later.
Secured Credit Card
Secured credit cards work like a standard credit card; only the account holder prepays their credit limit. At the beginning of the month, the account holder will contribute a cash deposit that will act as their credit limit for the month. This way, the user never accrues a credit card balance!
Charge Card
A charge card is a special type of credit card that has no spending limit but requires the account holder to pay off the balance in full each month. Charge cards are most commonly used for businesses that need to make large unexpected purchases but have the means to pay them off quickly.
Balance Transfer Credit Cards
A balance transfer card is a special type of credit card designed to help ease the burden of a consumer’s existing credit card debt. Characteristics of qualifying balance transfers for a transfer card are high-interest balances that the consumer can pay off in a few months or less. If your credit card balances are extremely high, you may benefit more from a debt consolidation loan over a balance transfer credit card.
Business Credit Cards
Business credit cards are lines of credit designated for business purposes only. Many employees are granted business credit cards if they frequently travel or often make other purchases that are directly business related.
Credit Card vs. Debit Card
Below is a breakdown of the core differences between a debit card and a credit card.
- Source of Funds: When you make purchases with your debit card, funds come directly from your checking account. With credit card purchases, funds come from your pre-approved credit limit, which you are responsible for paying back later.
- Liability for Fraudulent Transactions: If someone steals your debit card, they can potentially take all the money from your checking account. While it’s possible to get this money back, it may take time and can be extremely inconvenient while you wait. For fraudulent credit card purchases, all you have to do is dispute the charge and work with your credit card issuer to remove the fraudulent purchases from your balance. In this circumstance, the money in your checking account can remain safe and unaffected.
- Impact on Credit History: While a bank account opening may have little effect on your credit score, applying for and opening a credit card account may result in a slight reduction in your credit score. However, using your credit card and promptly paying off your balance may help increase your credit score over time.
- Spending Limits: With your debit card, your spending limit is the amount of money you have in your bank account. For a credit card, you may spend until you have reached your credit limit.
Interest Rates and Fees Associated With Credit Cards
Many credit cards come with a set interest rate. If you come across a credit card you like but want a lower interest rate, you may have to find another credit product. Or depending on your credit score and financial history, you can talk to the credit card issuer about receiving a different interest rate.
Similar to other issuers, credit card lenders typically determine interest rates based on the credit score, income, and general financial history of the applicant/borrower. Usually, the higher your credit score, the more opportunities you will have to receive more favorable interest rates on loans, lines of credit, and other financial products.
Annual Percentage Rate (APR)
The annual percentage rate (APR) indicates the percentage of interest charged over the course of a year. You can calculate how your APR will impact your monthly balances by dividing your existing APR by 12 and then multiplying that amount with your current balance.
For example, say you had a credit card with a 21% APR. If you had a monthly balance of $650, you could calculate your interest charges by taking 21% and dividing by 12, resulting in 1.75%. You can then convert the percentage to a decimal and multiply it by your monthly balance, so 0.0175 x $650, which is approximately 11.38. This means that $11.38 in interest will be added to the existing monthly balance of $650, bringing the total amount you must pay to $661.38.
What Is a Penalty APR?
Some credit card issuers penalize borrowers who make late or delinquent payments by raising their APR. This rise in APR is designed to deter customers from becoming delinquent on their credit card account. Unfortunately, if you are having trouble keeping up with your credit card balance and miss payments, a penalty APR may make your balance even more challenging to pay off.
Annual Fees
Some credit cards that come with rewards will charge an annual fee for the perks and services provided with the card. This fee is an additional charge borrowers are responsible for every year, regardless if they utilize the perks/rewards or are carrying a balance.
Late Fees
Almost every financial product will charge late fees to borrowers who fail to make payments or who make them after their designated due date. To avoid getting charged late fees, make sure you are making your due payments on or before their due date. You may also sign up for autopay to stay on top of your due payments without having to remember to manually put the payment through.
Balance Transfer Fees
Balance transfers almost always come with fees. These fees may be a set amount or a percentage of the total transfer amount.
Foreign Transaction Fees
If you are using a credit card in another country, each purchase may come with a foreign transaction fee. These fees are meant to compensate for the cardholder’s issuer converting currency during the transaction. Furthermore, foreign transaction fees are not just limited to brick-and-mortar locations when traveling abroad. Borrowers may also come across foreign transaction fees when making online purchases from stores that are based in another country as well.
Pros and Cons of Credit Cards
Credit cards have advantages and disadvantages all borrowers should consider before they apply.
Convenience
Credit cards can come in handy when you need to make due payments but don’t have enough cash in your checking or savings accounts. For example, say you forgot a security deposit you needed to move into an apartment. If you didn’t have sufficient funds in your checking account to cover the expense, you could use your credit card.
However, while your credit card can be a lifesaver when it comes to paying surprise expenses, it’s important not to get into the habit of relying on your credit card for recurring expenses, like your monthly cell phone bill. Habits like this may cause you to build up more credit card debt than you can handle.
Opportunity To Build Credit History
Using your credit card wisely may help you improve your credit report and boost your credit score! To build credit history with your credit card, take advantage of the following tips:
- Practice responsible spending and avoid overspending.
- Try not to carry a balance.
- If you do have a balance, make your monthly payments on time.
- Monitor your credit reports to see how your spending habits affect your finances.
Purchase Protection and Security
In the unfortunate circumstance that your credit card is stolen, you can freeze your account immediately and prevent the thief from being able to make purchases. You can also refute fraudulent purchases so you won’t end up having to pay for them. In a situation like this, your credit card issuer would assume the loss and remove the fraudulent purchases from your transaction history and balances.
To help protect yourself from credit card fraud and identity theft, you can:
- Keep credit card information, including pins and passwords, private.
- Monitor your credit card transactions and review your monthly statements.
- Report discrepancies immediately.
- Take advantage of security features like two-factor authentication and chip cards.
Reward Programs
Many credit card companies offer perks like cash back, redeemable points, travel points, or cash rewards. If you use your credit card for purchases you would already have to make (gas, groceries, etc.) and pay off your balance quickly, you could essentially earn free money!
International Credit Cards
Borrowers may also be considering travel-specific credit cards, airline credit cards, or hotel credit cards to save as much money as possible while vacationing or traveling for work. For example, consumers may use the Venture Rewards Credit Card to earn miles and perks.
The Downside of Credit Cards
There is no denying that credit cards can be extremely convenient and helpful. But, they may also come with serious consequences when not used responsibly.
Risk of Overspending
Borrowers who don’t keep track of their credit card spending may develop bad habits when it comes to making purchases with their credit. Since money never really leaves your hands or checking account, it can be hard to visualize the impact of habitual spending. It may come as a rude surprise when you view your total balance and see how much your monthly spending has affected your overall finances.
Risk of Accumulating High Balances
The higher your credit card balance, the higher the interest rate charges you will accrue. If your spending gets too out of hand, you may find yourself with interest rate charges that are so unmanageable that minimum monthly payments aren’t enough to reduce your overall balance.
Tips for Reducing Credit Card Debt
If you find yourself in a situation where your credit card debt is starting to stress you out, you may find the following tips helpful.
Pay More Than Your Minimum Payment
To reduce any balance faster, whether it be a credit card or personal loan balance, try to make payments that are larger than the minimum amount due. In addition to making larger payments, you may also consider making more frequent payments. However, if you decide to make additional monthly payments, make sure you contact your credit card issuer so they know to designate your funds towards your current balance and not the next month’s spending.
Stop Making Purchases Using Your Credit
It is also a good idea to stop making purchases with your credit card while you are working on paying down your debt. While it may not be a good idea to cancel your account to prevent yourself from spending using credit, you may consider keeping your account open and physically destroying your credit card. That way, you can stop yourself from using it to make purchases that can hinder your debt repayment but still benefit from the credit utilization.
Avoid Additional Credit Inquiries
In addition to ceasing the use of your credit card until you have paid off your debts, you may also want to avoid applying for new loans or credit cards as well. Not only does applying for funding affect your credit score, but it may also increase the amount of debt you have if you are approved.
How To Choose a Credit Card
With so many credit card products available, it’s important to pick the right one that will suit your finances the best.
Consider Your Personal Financial Goals and Spending Habits
To choose the best credit card for you, first think about your personal financial goals and spending habits. What are you looking to pay for with your credit card? If you are looking to make purchases towards a vacation with your card, you may benefit most from a travel card that offers cash-back perks or frequent flyer miles. Or, if you are simply looking to have a safety net should surprise expenses pop up, a standard credit card may work just fine for you.
Compare Lenders and Products
After thinking about your financial goals, do some research on credit card lenders and the products they offer.
Credit Card Comparison
Below is a quick comparison of some popular credit cards on the market.
Keep in mind that credit card companies often change specifics about their products and services. So, if you visit the website for any of the creditors we mention, you may find even more updated information about the credit cards listed below!
Wells Fargo Active Cash® Card
Annual Fee: $0
Rewards: Unlimited 2% cash-back
Intro offer: $200
Chase Sapphire Preferred® Card
Annual Fee: $95
Rewards: 1x-5x points through the Chase Ultimate Rewards card program.
Intro Offer: 80,000 points
Citi Simplicity® Card
Annual Fee: $0
Rewards: None.
Intro Offer: None.
Chase Freedom Unlimited
Annual Fee: $0
Rewards: 1.5%-6.5% Cash-back.
Intro Offer: $300.
Capital One SavorOne Cash Rewards Credit Card
Annual Fee: $0
Rewards: 1%-10% cash-back.
Intro Offer: $200.
American Express® Gold Card
Annual Fee: $250
Rewards: 1x-4x points.
Intro offer: 60,000 points.
Credit Card Eligibility Requirements and Considerations
When determining approval, credit card lenders will take a look at several aspects of your current finances and financial history.
- Credit Score: Credit card issuers may take a look at your most recent credit report to review your credit score and confirm you are not currently going through the bankruptcy process.
- Income and Employment: Your credit card issuer will also want to confirm you have sufficient means to pay off your monthly balances.
- Debt-to-Income Ratio: Your debt-to-income ratio indicates how much debt you currently have compared to the amount of money you bring in regularly.
- Existing Credit Cards and Accounts: Credit card lenders will also take a look at your existing financial accounts, such as installment loans, payday loans, other credit cards, etc.
Credit Card FAQs
Below are some frequently asked questions consumers have about credit cards.
Can I Take Out Cash With a Credit Card?
Yes! Most credit cards allow you to take out cash advances against your credit limit. To access cash advances with your credit card, you can visit an ATM and withdraw cash just as you would with your debit card. However, be aware that the interest rate charges on credit card cash advances are typically higher than rates associated with standard purchases using your credit.
How Much Can I Spend With a Credit Card?
Your credit limit will indicate your maximum spending cap for the month. If you would like to spend beyond your credit limit within a single billing period, you will have to pay off part of your balance for that month. Keep in mind that you don’t have to spend until you reach your credit limit each month. In fact, you should try to avoid developing such habits to prevent yourself from accumulating overwhelming credit card debt.
What Happens if I Pay My Credit Card Late?
Borrowers who make late or delinquent payments on their credit card bills may suffer the following consequences:
- Late payment fees.
- Penalty APR.
- Decrease in credit score.
- Difficulty receiving credit approval in the future.
What Are the Interest Rates on Credit Cards?
Interest rates for credit cards may depend on the specific credit card product or on the creditworthiness of the account holder. Also, remember that credit card interest rates are charged against the amount of money the borrower has spent, not their total credit limit.
How Long Does It Take To Get a Credit Card?
Some credit cards have online promotional offers that allow borrowers to receive approval the very same day they apply. Other credit card lenders may take a few days to determine approval. After approval, you may have to wait for your physical credit card to come before you can start making purchases, which can take a few days or weeks, depending on the shipping methods used.
How Many Credit Cards Can I Have?
Borrowers are allowed to apply for as many credit cards as they like. But, if you already have a credit card with a high balance, you may have trouble finding approval for additional cards or lines of credit. It may be in your best interest to have a single credit card and request an increase in your credit limit if you find you need additional funds.
Can I Get a Joint Credit Card?
Typically, no. Credit cards can usually only be in the name of one account holder. However, it may be possible to have multiple authorized users on a single credit card account. This way, multiple people can use the same credit card account, functioning similarly to a joint credit card.
Can I Cancel My Credit Card Account?
While you can cancel your credit card account at any time, this may not be the smartest decision for you financially. If your credit card is your oldest financial account on file, canceling your account may reduce your length of credit history, which may harm your credit score. Furthermore, canceling a credit card will also reduce your credit utilization, which can also have a negative impact on your credit score.
However, sometimes canceling a credit card is the only sustainable option. Some signs that it may be time to cancel your credit card account are:
- If you cannot resist the urge to shop impulsively.
- You can no longer afford your annual fees or other credit card costs.
What Happens if My Credit Card Is Lost or Stolen?
As soon as you discover your credit card is either lost or stolen, contact your issuer and freeze your card immediately. This will prevent any future purchase transactions from going through, so if your card is stolen, the thief will no longer be able to use it.
Next, look at your current transactions/statements and dispute any unauthorized charges. After you report your credit card missing or stolen to your issuer, they can arrange for you to receive a replacement card with updated payment information.
Bottom Line: Credit Cards
Credit cards can be a wonderful financial tool for consumers, but they can also be quite harmful to one’s finances if left unchecked. Use your credit card wisely by avoiding impulse purchases and overspending, keeping your balance low or nonexistent, and making sure you submit all your due payments on time.
References:
Wells Fargo Active Cash® Card
Chase Sapphire Preferred® Card
Citi Simplicity® Card
American Express® Gold Card|
Capital One SavorOne Cash Rewards Credit Card
Chase Freedom Unlimited