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How do credit cards work? A beginner's guide.
Credit cards are convenient payment tools that can serve as an alternative to debit cards or cash. While most credit cards look and feel similar, they vary a lot in terms of their purpose and target users. Some cards are designed for people who want to build credit or consolidate debt, while others are ideal for frequent travelers or those who want to earn cash back.
If you want to add a new card to your wallet, here’s how credit cards work, the pros and cons of credit cards, common types, and how to choose the best card for you.
In this article:
How do credit cards work?
Credit cards are a type of revolving credit, which means you can charge purchases to your account up to your credit limit, repay your balance, and spend again. When you make purchases with your card, your total available credit decreases. When you pay down your balance, your total available credit goes back up. If you don’t repay your balance in full each month, the amount you carry over will collect interest.
You can typically apply for a new credit card online. When you do so, the card issuer will ask for some basic personal information, such as your name, address, email, and annual income. If approved, your card issuer will give you a credit limit, which you can spend against and pay down monthly. You’ll generally receive your physical card by mail in 5-10 business days.
After that, you can begin using your new card. When you pay a bill online or make an in-store purchase with your credit card, your card information is shared with the recipient’s bank. The bank processes the transaction through a payment network and attempts to authorize the transaction with your card issuer. Your card issuer verifies your details and then approves or denies the transaction.
Most card issuers report your credit card payments to the three credit bureaus: Equifax, Experian, and TransUnion. With responsible credit use and consistent, on-time payments, a credit card could help improve your credit over time.
Learn more: How do credit card companies make money?
Pros and cons of credit cards
Before applying for a new credit card, it’s important to be aware of the benefits and drawbacks of these payment tools.
Benefits
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Can improve your credit if used responsibly
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Many cards offer rewards or other perks
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Access purchase and fraud protections
One of the primary benefits of getting a credit card is that responsibly using it can help build your credit. Making on-time monthly payments and keeping your debt under control will typically result in a higher credit score over time, which may make it easier to qualify for future loans, get more favorable insurance rates, and more.
Some credit cards also offer rewards, travel protections, and other perks. Racking up rewards with your everyday spending can help you offset your credit card balance or the cost of hotels, flights, car rentals, and more.
Lastly, credit cards can be safer to use than cash or debit cards. If you don’t receive the product you paid for or someone has made unauthorized charges to your account, for example, you can dispute those costs with your card issuer and potentially be eligible for a refund. In addition, purchase protections are common on credit cards, so if a recently purchased item is stolen or damaged, you may be eligible for reimbursement.
Drawbacks
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High interest rates can make it hard to get out of debt
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Potential for added fees
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Can hurt your credit if not managed wisely
Credit cards generally come with high interest rates, so they aren’t the best payment option if you carry a balance month to month. Interest costs can add up quickly in that case, making it difficult to repay what you owe. Likewise, credit cards may have added costs such as annual fees or late payment fees. That said, annual fees can often be offset by strategically using your card’s rewards.
As with most loans and credit lines, if you miss a monthly payment or pay late, your credit score may also suffer. Your payment habits have a major impact on your credit score, so it’s important to prioritize on-time payments.
Common types of credit cards
There are several types of credit cards, each with specific benefits for different people. Some benefits might overlap between card types. For instance, certain secured cards also offer cashback rewards. The right card for you will depend on your individual needs and preferences.
Secured credit cards
Secured cards are designed to help you build your credit. They’re ideal if you have thin credit or past credit struggles, as many secured cards don’t require good credit for approval.
This type of card generally requires that you make a security deposit, which typically serves as your credit limit. Your card activity is reported to the credit bureaus, so on-time payments can improve your score over time. In addition, many issuers allow you to upgrade to a traditional credit card after you’ve proven you can safely use a secured card.
0% APR credit cards
Cards with a 0% promotional interest rate are ideal if you want to transfer debt from high-rate cards or are planning to make a large purchase. These cards offer a 0% interest rate for a set period, often as long as 15 or even 21 months, which lets you repay a fairly large balance over time without incurring interest charges.
Credit cards with 0% introductory APRs often require good or excellent credit for approval.
Cash-back credit cards
With a cash-back card, you can earn money back on every purchase you make. Depending on the card, your rewards can be redeemed for cash or a statement credit. The percentage of cash rewards you receive depends on the card and issuer, with the best cards offering 5% or more back in select categories.
Good or excellent credit is typically required to qualify for the best cash-back cards.
Travel rewards cards
If you take regular trips for business or vacation, a travel rewards card could be ideal. These cards typically earn flexible rewards and have generous welcome offers you can earn after spending a minimum amount when you first open the account.
While some travel cards may have relatively high annual fees, these costs can usually be offset by maximizing the card’s benefits. Some cards offer travel credits, too, allowing you to be reimbursed for flights or hotel stays.
You can opt for a general travel card or one that earns rewards with a particular airline or hotel brand. You’ll need good or excellent credit to qualify for the best travel cards.
How to choose the right credit card
If you’d like to apply for a credit card, consider the following to find the best one for your situation.
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Credit: Different types of credit cards have varying credit score requirements. For instance, you might qualify for a secured card with fair or poor credit, but top travel cards generally require excellent credit.
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Goals: You can accomplish specific goals with different types of cards. For instance, a travel card could help make trips less expensive, while a 0% APR card could help you pay down existing debt.
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Rewards: Cards come with different rewards programs, or no rewards at all. Consider whether you want to earn general travel or cashback rewards, or if you want to earn hotel or airline points with a favorite brand.
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Fees and interest: As you compare options, look at card fees and interest rates. Common costs include annual fees, late payment penalties, balance transfer fees, and cash advance fees. Keep in mind that credit card rates are generally higher than rates for other types of credit lines and loans.
Frequently asked questions (FAQ)
Do credit cards affect your credit score?
Yes, credit cards can affect your credit score. When you apply for a new card, the card issuer will often do a hard credit pull, which can ding your score by a few points — but this dip is temporary.
Your payment habits and debt levels can also impact your credit score. Making consistent monthly payments and keeping your debt manageable can help boost your credit.
What if I only pay the minimum due on my credit card?
While you can charge up to your credit limit, you have the option to only make minimum payments each month. This is usually a flat percentage of your total balance and represents only a small fraction of your total balance. Any remaining balance on your account will begin accruing interest.
While it can be tempting to only pay the minimum amount, doing so can quickly lead to high interest costs and ever-increasing credit card debt. If you can afford to do so, pay off your entire card balance each month to avoid interest. If you must carry a balance on your card, however, make the largest monthly payment you can afford and create a budget to pay off your credit card debt as quickly as possible.
What’s the easiest credit card to get?
Exact requirements to get a credit card vary by issuer, and approval decisions are typically based on your credit, income, employment, and other factors.
However, secured credit cards are generally among the easiest cards to get. These cards can help users build or rebuild credit. Some, such as the OpenSky® Secured Visa® Card, don’t require a credit check at all when you apply. Secured cards typically come with lower credit limits and fewer perks, but they can be a useful stepping stone until your credit has improved enough to apply for a traditional card.
This article was edited by Alicia Hahn
Editorial Disclosure: The information in this article has not been reviewed or approved by any advertiser. All opinions belong solely to Yahoo Finance and are not those of any other entity. The details on financial products, including card rates and fees, are accurate as of the publish date. All products or services are presented without warranty. Check the bank’s website for the most current information. This site doesn't include all currently available offers. Credit score alone does not guarantee or imply approval for any financial product.
