Buy and Borrow

How Do Credit Cards Work?

Erin Palmer

June 21, 2021

Woman thinking of credit card terms

Credit cards can be a helpful tool for your financial life. You can use them to establish and build credit. They can offer convenience for making everyday purchases. Some even reward you when you use them!

Before deciding if you’re ready for your first credit card, or a different credit card to better fit your needs, it can be helpful to understand how credit cards work.

Credit Card Basics

A credit card is a card that lets you make purchases using a line of credit. Think of it like a short-term loan. Each time you use a credit card, you are borrowing money from the lender that issued the card. You are responsible for paying that money back.

You can either pay back the amount in full, or pay for the item over time by making payments. Your lender will send a bill that states the minimum payment due for that month. When you carry a balance on a credit card, like if you are still paying off a past purchase, you also pay interest based on the interest rate of the card.

How Do Credit Cards Work?

When you apply for a credit card, lenders look at factors like your income, debts, and credit history to determine if you are approved and what your credit limit should be. Your credit limit is the maximum amount you can borrow using your credit card.

Your lender will bill you each month based on the terms of your credit card. When you make payments on time, it can help build your credit and increase your credit score. If you make late payments, it could have a negative impact on your credit score. You also might incur late fees, depending on the rules of your specific credit card.

Your credit score is used by lenders to help determine your credit worthiness when you apply for things like a car loan, mortgage, or renting a home. Using a credit card responsibly is a great way to build your credit over time.

How to Choose a Credit Card

There are many credit cards to choose from, depending on your needs. For example, starter credit cards can be a good fit for someone looking to establish credit history for the first time.

No matter what type of credit card you’re considering, there are certain factors to keep in mind during your decision making process:

  • Annual Percentage Rate (APR): APR is the interest you’ll pay on credit card purchases when you carry a balance. A lower APR means you’ll pay less in interest over time. Having a higher credit score can help you qualify for a lower APR in the future.
  • Annual fees: Lenders sometimes charge an annual fee for their credit cards. This is a fee you have to pay each year. However, there are also credit cards that do not charge an annual fee. Finding a credit card with no annual fee can save you money.
  • Rewards: Credit cards may come with rewards for using the card. It could be cash back, bonus points, or other items. Rewards can be an excellent feature, though it’s still important to consider the overall terms of the credit card first to see if the card is right for you.
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