Credit Cards Made Easy: How Credit Cards Work

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Credit cards are important financial tools but can be detrimental to your finances if mismanaged. How do you leverage their advantages without falling prey to their disadvantages? Here’s everything you need to know.

What Are Credit Cards?

Credit cards are thin rectangular pieces of plastic or metal issued by a bank or other financial institution. They allow the cardholder to use the card to borrow funds in order to pay for eligible goods and services.

Typically, credit cards require that you pay back the borrowed money, plus any applicable interest and/or fees. Each month, your credit card bill is due and you are required to make a payment on the card. You can pay off the entire balance or choose to pay the money back over time.

Credit cards can open up a whole new world of buying power. They can also help you build your credit score and increase the chances that you’ll be able to get financing, take out loans, and more. It’s important to understand that credit cards are not a form of income.

In fact, credit cards are a form of debt. They represent a lender’s decision to offer you funds in exchange for you repaying that money plus interest. So, while they do increase your buying power, they do not add to your net worth. They detract from it.

While some argue because credit cards are a form of debt, they should be avoided, the truth is that they can be very useful tools when used correctly.

Benefits of Having a Credit Card

Credit cards offer many different benefits when used as a strategic part of your financial planning. And while some of those benefits will vary from card to card based on the type, some apply across the board.

Credit Cards Can Improve Your Credit

When used correctly, credit cards can help you build and improve your credit score. When you’re shopping around for a credit card, make sure that the card issuer reports your monthly payments to the three major credit reporting agencies (Experian, Equifax, and TransUnion).

Once you get the credit card, all you will need to do is make a few small purchases and pay your bill on time. The card issuer will report the on-time payment and your credit score will increase. Keep it up and you can create a strong credit history that shows consistency and responsibility.

You Get Access to Better Interest Rates

This benefit is a byproduct of responsible credit card use. When you have a higher credit score and strong payment history, lenders will see you as less of a risk.

After you spend some time managing your credit card responsibly, you can enjoy lower interest rates and more affordable loan terms for things like auto loans and home mortgages, which can be incredibly expensive if you only qualify for high interest rates.

Credit Cards Can Help in Emergencies

Credit cards often come with interesting extras that you might not realize, such as cell phone protection, extended warranty protection on purchases, return and purchase protection, and more.

You also get access to extra funds to handle emergencies that life might throw your way, such as unexpected car repairs or the need for medical care not covered by your health insurance.

You Gain Access to Rewards

Some credit cards offer access to rewards and perks. As you spend on the card, you accrue points. Those can be redeemed for things like discounts on shopping purchases, air travel, hotel rooms, and so much more. Note that each reward program varies, so you’ll need to compare your options to get the right card for your needs.

FAST FACT : According to a recent study by J.D. Power, American Express ranks the highest in customer satisfaction among national issuers. Discover came in a close second followed by Capital One in third.

5 Different Types of Credit Cards

You might think that all credit cards are basically the same, but that’s not the case. You’ll find several different types out there and it’s important that you choose the right one for your needs. Here are five different types of credit cards:

1. Unsecured Credit Cards

Unsecured credit cards are by far the most popular type out there. Unsecured credit cards aren’t “secured” by any collateral. Once you’re approved for the card, you sign a contract promising to pay back the credit card company any balance that you owe.

Unsecured credit cards are usually a bit harder to get approved for and are accompanied by a higher interest rate. That interest rate is imposed to compensate for the lack of collateral.

2. Secured Credit Cards

If you’re looking for a way to build or rebuild your credit, a secured credit card could be just the ticket. Unlike unsecured credit cards, a secured card is backed by collateral. When you open the account, you make an initial deposit into the account that determines your credit limit.

Basically, you fund the account out of your own pocket and then spend the money on things you need. The card issuer reports your payments to the three credit bureaus and you will see an increase in your score as long as you pay your monthly bill on time.

3. Student Cards

These cards are designed for those just starting to build their credit, usually college students. Most student credit cards have no annual fee and a low interest rate. However, be careful when using them. Often, students who have little experience with credit cards can run up massive bills and damage their credit.

4. Rewards Cards

From travel to groceries and gas, you’ll find reward cards designed to work with many different lifestyles and offer a wide range of reward types. You can find everything from the ability to earn cashback on everyday purchases to airline miles when you use a rewards card.

5. Balance Transfer Cards

If you are carrying debt on a high-interest credit card, a balance transfer card can help you reduce the interest that you’ll pay. Most balance transfer cards come with a 0% annual percentage rate (APR) for the first year or so. This means that you could make a big dent in paying down your debt without paying anything in interest.

Credit Card Terms to Know

If you’re applying for credit cards, you may come across many different terms you’ve never heard before. Here are some of the most widely-used credit card terms and what they mean.

Interest Rate

An interest rate is an amount a lender charges you if you carry a balance over from month to month. The higher the interest rate, the more you’ll have to pay. Most credit cards come with a higher interest rate than you’ll find with a personal loan or auto loan.

Annual Percentage Rate (APR)

Annual percentage rate (APR) refers to the yearly interest that includes interest and other charges. The APR can provide you with a bottom-line number that you can use to compare other offers out there. The lower the APR, the better!

Finance Charge

A finance charge is a fee that is charged for things like cash advances that add to the cost of your credit card. Depending on your card issuer, a finance charge may be a flat fee or a percentage of the borrowings.

Late Fees

If you’re late on your payment, you’ll be charged a late fee (and the late payment will be reported to the credit bureaus). Always remember to pay on time and contact your card issuer if you cannot make a payment on time that month.

Grace Period

This is a period of time during which you can pay your bill without incurring any interest charges or penalties. This period usually spans between 15 – 25 days.

Annual Fee

Think of this as a membership fee. Some credit cards charge an annual fee for you to own the credit card. Not all card issuers charge annual fees, so it may be smart to find an option that doesn’t have one tacked on.

The Difference Between Card Issuers and Payment Networks

You’ve heard of Visa and MasterCard, but did you know that they aren’t actually credit card issuers? They are payment networks. Banks issue the cards and then Visa or MasterCard process the payments. Here’s why this is important to know.

Every bank/credit card issuer is different. A Visa from one bank could come with very different terms and conditions, fee schedules, interest rates, perks, and rewards than a Visa from a different bank. The same thing applies to MasterCard.

It’s important to look at both the payment network (Visa, MasterCard, etc.) and the card issuer. You need to make an informed decision when applying for cards, so you’ll want to consider things like:

  1. The introductory APR and the interest rate after the introductory period ends
  2. Any annual fees charged by the issuer
  3. Fee schedules
  4. Late fees charged
  5. Credit limit

By doing a little extra research to lock down the right card for you, you will be able to save money on fees and be able to enjoy a credit card that’s right for you.

7 Tips to Getting the Most Out of Your Credit Card

A credit card can be either a powerful financial tool or a detriment to your financial wellbeing. Here are seven tips that can help keep you out of the weeds and on the road to building a strong credit history.

Tip #1: Know Your Costs

The amount you pay for using a credit card is never as simple as the balance plus interest. There are other fees tacked on here and there and they’ll drive your costs up. Know those costs and shop for the right card. Be informed and comparison shop so you can make the best decision for your specific needs and goals.

Tip #2: Go for a Secured Credit Card First

If you have no credit or bad credit, don’t apply for an unsecured card. That could lower your credit score even further. Instead, apply for a secured card and commit to rebuilding your credit.

Even if your credit is moderate, there’s a lot to be said for improving your score before applying for an unsecured card, as it will help you get a lower interest rate and open up better cards that would be otherwise inaccessible to you.

Tip #3: Stick to 30% Credit Utilization

The golden rule of credit card usage is this – use no more than 30% of your credit limit. Going beyond that point can hurt your credit history and score. The best idea is to pay off your entire credit card balance each month.

If you keep a high balance on your credit card from month to month, you will not only damage your credit score but you will also have to pay extra interest fees.

Tip #4: Don’t Close Credit Card Accounts

You might be tempted to close cards that you’re no longer using, but if they don’t have an annual fee, keep them open. The more open cards you have, the better your overall credit utilization. You will also maintain a solid payment history – which is another crucial part of your credit score.

Tip #5: Pay On Time All The Time

Don’t miss a payment. Don’t pay late. Be on time with your payments all the time. Otherwise, you’ll be on the hook for late fees plus your credit score will take a hit.

Tip #6: Don’t Believe There’s a One-Size-Fits-All Card

The right card for you may be the wrong card for someone else. Take your time and compare your options. Look at the rewards offered, the fee structures, the APR and interest rates, annual fees, and even charges to cancel the card.

Look at where your card is accepted, how it will fit into your life, and whether it will help you achieve your goals. Only then should you apply with an issuer.

Tip #7: Pay More Than the Minimum Amount

The best option is to pay off your charges the same month that you make them, as this usually lets you avoid interest charges. However, that’s not always possible.

If you end up carrying a balance on your card from one month to the next, pay more than the minimum payment. Otherwise, you’ll carry that debt for an incredibly long time.


Credit cards can be powerful financial tools when thoughtfully chosen and used responsibly. With the being said, they can also easily become stumbling blocks. Shop around for the right credit card and consider a secured card if you have no credit, low credit, or bad credit.

Even if your credit score is “decent”, consider taking time to improve it before applying for a card, as the benefits are well worth it in terms of lower interest and access to better rewards.

Finally, be conscientious with your use. Realize that every purchase can incur interest charges and commit to paying off your balance as quickly as possible. With care, conscious use, and the right approach to credit, you’ll be well on your way to enjoying the benefits credit cards have to offer.

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