How do credit cards work?

Credit cards are financial instruments that offer access to a line of credit that can be used for purchases, balance transfers or cash advances. When you use a credit card, you’re borrowing money from the issuer to make the transaction, and then repaying that loan at the end of each billing cycle, either in part or in full. You should pay your bill in full each month to avoid being charged interest. If you can’t pay your balance in full, at least make the minimum payment required. Interest will still be applied to the remaining balance, but you won’t damage your credit score.

Many credit cards also reward cardholders with cash back, points or miles for every purchase made. Plus, the best credit cards often come with signup bonuses that cardholders can earn after meeting a minimum spending requirement in the first few months. Credit cards offer short-term loans and give rewards because it’s profitable for credit card issuers. If a cardholder decides to pay off a credit card balance over time, they’ll have to pay interest. And if they have the chance to earn rewards, they’re likely to spend more than they would otherwise.

Generally, credit cards with the best rewards, rates, and benefits go to people with high credit scores and little-to-no debt. Essentially, the most proven and creditworthy individuals get the best credit cards. But if you’re new to credit, credit cards are the best credit-building tools around. Even if you never use the card to make purchases, the issuer will report positive information to the credit bureaus every month. And it’s very easy for someone with no credit to get a card, especially a secured card where your credit limit is based on how much you put down as a security deposit.

How Credit Cards Work:

• Credit cards allow users to buy now and pay later, even over the course of months.
• If cardholders don’t pay their full balance by the due date each month, interest charges are added to the balance each day.
• Credit cards allow cardholders to build credit, unlike debit cards. Having good credit is extremely important when it comes to renting an apartment or buying a home, and can get cardholders better rates on things like insurance and mortgages.
• Some credit cards reward cardholders for making purchases. Some cards charge annual membership fees.
• Credit card approval depends on an applicant’s overall creditworthiness. Credit history, income and debt obligations are important factors.

Now that you’ve been introduced to credit cards in general, it’s time to get better acquainted with the various types of credit cards that exist, the ways in which they could cost you if you’re not careful, and why you really should get one at the end of the day. You can find all of that and more below.

Types of Credit Cards

There are well over 1,000 credit card offers on the market right now. That might seem overwhelming, but credit cards can be grouped into several categories that make them more digestible.

• Cash Back Credit Cards

Cash back credit cards reward users by returning a certain percentage of each purchase made. You can then redeem the cash back that you earn for credits toward your card’s bill, paper checks, bank account deposits, or gift cards for your favorite stores. The options vary by card.

• Travel Rewards Credit Cards

Travel rewards credit cards offer points or miles on purchases that you can then redeem to pay for recent travel expenses and/or future trips. Some travel credit cards are affiliated with specific airlines, hotels or other travel companies. Others give rewards that work equally well for all travel.

• Business Credit Cards

Business credit cards can only be used for business purchases and are only available to business owners or other company representatives. They usually reward users with cash back or travel miles, often providing bonus rewards in purchase categories popular with the business community. Business credit cards also come with benefits particularly useful to business people, like airport lounge access and helpful expense tracking tools.

• Student Credit Cards

Students with limited or no credit history can get better credit cards than their lack of experience would otherwise merit. Credit card issuers recognize that college graduates are likely to earn more in their lifetime than non-graduates. Students also tend to be relatively young. That is a combination that could lead to years and years of highly profitable banking needs for a financial institution that gets in early to fulfill.

• Secured Credit Cards

Secured cards require a security deposit, which then acts as your credit limit (the amount you can spend on your card). Since you can only spend as much as you’ve deposited, the risk is much less for issuers, and they’ll approve less creditworthy individuals who may not be able to get other cards. Secured credit cards can help you build credit just like any other credit card, however.

There are plenty of other ways to segment the credit card market, too, including by the credit rating required for approval. To learn more, check out WalletHub’s breakdown of all the different types of credit cards available right now.

How Does Credit Card Interest Work?

Credit card interest is charged on whatever balance you carry from billing period to billing period. Credit card interest rates are some of the most expensive interest rates you’ll come across, so it’s best to pay your bill in full each month. If you have a balance remaining after the due date, interest charges are applied immediately. Even worse, interest continues to be added on each day, and the previous day’s interest becomes part of the balance you owe interest on the next. You have to pay two consecutive bills in full to break this cycle.

If you can’t pay your full credit card bill by the due date, be sure to make at least the minimum payment. Minimum payments differ card-to-card but are usually a flat fee, like $25, or a small percentage of your balance, like 2%-3%. Making the minimum payment does not prevent interest from being charged on the remaining balance, but it does prevent you from being charged late fees and your credit score from being damaged.

For a more in-depth look at credit card interest, how it works, and mistakes to avoid, check out WalletHub’s credit card interest guide.

Credit Card Fees

An annual fee is the yearly cost of simply owning whatever credit card you have. There are plenty of credit cards with no annual fees, so it’s easy to avoid paying if that’s your priority.

There are other fees that could come into play, too. For example, late fees are assessed when you don’t pay your credit card bill on time, and are usually around $35-$38. Balance transfer fees apply when you move a debt from a credit card or loan to a new credit card account. And cash advance fees apply when you use your credit card to get cash from an ATM or bank teller. Balance transfer and cash advance fees are usually either a percentage (like 3%-5%) or a flat fee (typically around $10), whichever of those is more.

If you want to learn more, take a closer look at the most common types of credit card fees and how to avoid them.

Should You Get a Credit Card?

Yes, you should get a credit card. If you’re able to get a credit card and use it responsibly, the benefits far outweigh any potential negatives. For instance, using a credit card is the easiest way to build your credit, which is important for many things you’ll do in life. Even just having open credit cards, regardless of how often you use them, helps build credit.

Getting a credit card can be a daunting process, but WalletHub’s editors have made it easy. We’ll guide you through everything from deciding which type of credit card you should get and how to apply for your card of choice, to what you should do if your application is denied.

For personalized credit card recommendations, you can also sign up for a free WalletHub account. It’s easier than ever now to get a credit card, and with all of the great rewards and other perks to choose from, there’s little reason to wait.

Hi!  Thanks for writing!  A credit card (as opposed to a "debit card" which is a card that lets you pull money right out of your account without the hassle of having to write a check) lets you buy things and pay for them later.  It is a type of loan or debt called "unsecured debt." "Secured debt" means that there is a tangible asset such as your car or house as collateral for the loan. Rates tend to be lower for secured loans because lenders figure they can sell the house or boat to get back their money if you don’t pay the loan back. "Unsecured debt" is guaranteed only by your promise to pay it back. If you don’t pay, lenders will work to get their money back, but, as the saying goes “you can’t get blood out of a turnip.” So lenders run risk never getting the money they lent to you back. That’s why they charge a higher interest rate on unsecured debt.

A credit card lets you borrow conveniently, have money ready when you need it, especially in emergencies, and access a revolving line of credit. Credit cards require a minimum payment each month, but if you only make the minimum payment you incur a high rate of interest (between 13% and 25% or even more). Credit cards are useful because they help during emergencies; are safer and more convenient than carrying cash; allow you to easily make large purchases; help you build a financial credit history that in turn helps you get mortgages, home rentals, insurance and even job more easily and at lower rates; yield travel and other rewards; and let you spend money you don’t have. The primary disadvantage of a credit card is the same as its main advantage: it lets you spend money you don’t have, so you can get into financial difficulties if you spend more with your credit card than you can pay back. 

To get a credit card, you apply for one at one of the credit card companies - Wallet Hub has great comparison sites to check, compare, and apply.  Thank you so much for writing and best wishes to you!

In layman’s terms, credit cards let you borrow money up to an approved limit, which must be repaid. You'll be charged interest if you don't pay your full statement balance by its due date.

Positive payment activity will help build and improve your credit scores.