How Credit Cards Work 101

Credit cards can help you build credit, are convenient and offer consumer protection. However, they can be harmful if carelessly used. When you understand how they work, you will be able to choose the right one, manage it properly and save yourself money. 

Credit Card Basics

What Is a Credit Card?

It is a metal or plastic card through which you have access to a line of credit from the bank that gave you the card. Whenever you make a purchase with the credit card, you are covering the purchase by borrowing money from the issuer. You pay the money back over time or at the end of the month.

How Credit Cards Work

When your request for a credit card is approved, the bank will authorize a credit limit and you can use it at your discretion. Factors that determine your credit limit include available credit on your other cards, your debts and income.

Credit card transactions are processed by payment networks such as American Express, Discover, MasterCard and Visa. 

When you receive your bill, you can pay the entire amount or a specific minimum amount. The latter is more expensive because the interest will be higher.

The bank that issues the credit card will report your payment behavior to credit bureaus (these ones prepare credit reports). 35% of you credit score is determined by payment history. 

Difference from Other Cards

When you use a debit card to buy stuff, the money is deducted from your checking account directly. You use your own money. 

With a prepaid debit card, money is not deducted from your checking account because they are not linked. You instead spend the amount that you load onto that card.

Prepaid cards and debit cards have no effect on your credit score.

Types of Credit Cards


Reward credit cards, as the name suggest, offer you something whenever you make a purchase. You need good credit for these cards. They include:

  • Cash back cards
  • Hotel credit cards and airline credit cards
  • General travel cards
  • Store credit cards

If you pay your entire bill every month, these cards are ideal for you.

Low Interest

You do not get rewards with these cards. Instead, they offer a low interest rate.

Balance Transfer

with these cards, you can transfer your debt. You need excellent credit for these cards.

Cards for Bad or Average Credit

These cards have high interest rates and little or no rewards. You can use them to boost your credit score. A secured credit card is the best option for bad credit.

Student Cards

Unless you have a co-signer or proof of income, you cannot get a student card if you are under 21 years old.

Reasons to Get a Credit Card

  • Flexibility
  • Building credit
  • A 0% introductory APR period
  • Ongoing rewards
  • Sign-up bonuses

Costs of Carrying a credit Card

  • Interest payments
  • Annual fees
  • Late payment fees
  • Balance transfer fees
  • Foreign transaction fees

Tips for Credit Card Use

Pay on time.

Keep the balance below 30%.

Wait for six months or more before applying for another card.

Track you spending.

No-annual-fee cards should remain active and open.

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