Credit cards use electronic payment processing to facilitate convenient, secure purchases in seconds. When you use a credit card, you’re borrowing money from the credit card’s issuer to make the transaction, and then repaying that loan at the end of each billing cycle, either in part or in full. By paying the bill in full each month, you’re essentially getting a free loan, because you will be avoiding interest charges. If you can’t pay your balance in full, at least make the minimum payment required by the due date. Interest will still be applied to the remaining balance, but you won’t damage your credit score.
Many credit cards 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. Some credit cards offer low introductory interest rates, too.
Generally, credit cards with the best rewards, rates, and benefits go to people with high credit scores, a lot of income, 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. If you use the card responsibly and pay the bill on time every month, or never make purchases with the card at all, 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 credit card, especially a secured card where your credit limit is based on how much you put down as a security deposit.
This isn’t charity, though. 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.
Credit cards also work for transactions other than purchases, including balance transfers and cash advances, which have the potential to be even more profitable for issuers. Balance transfers give people the chance to repay existing debt with a lower interest rate, for a fee – usually 3% to 5% of the transferred amount. Cash advances let you withdraw cash from your credit line, but a high fee and interest rate apply right away.
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.
That’s how credit cards work, in a nutshell. That said, many of the finer details of credit cards – including all the types of credit cards available and how credit card interest works – don’t exactly fit in a nutshell. That doesn’t make them any less important to learn about, however, especially if you’re considering getting a credit card for the first time.