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How Do Credit Cards Work? | Easy Guide to Credit Cards

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5 months ago

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If you are interested in the convenience of instant payments, ensuring online transactions are as safe as possible, or want to get rewards for the money you spend anyway, you are a great candidate for a credit card. Whether you already have one and want to know how to better utilize its features or have never before enjoyed the thrill of spending plastic money, this article is for you.

Table of Contents

We will cover any and all things credit cards in this easy, definitive guide to getting and using credit cards:

The History of Credit Cards in America

While you might associate credit cards with the reckless spending habits of the 80s, they actually made their inaugural appearance in the 1950s with the founding of the Diners Club Card. Of course, this wasn’t exactly like the credit cards of today as it was a charge card that required users to pay their full balance each month, no minimum payments allowed. Eventually, credit cards evolved into the credit lines we know today. Bank of America issued the first credit card that featured a revolving credit option in 1958. The first charge card didn’t make its way onto the scene until later in 1958 when American Express joined the game.

These first versions of credit cards bear little resemblance to the ones we know today. They were often made of paper and provided little perks. Today’s cards of course include magnetic strips and chips, all designed to keep the user’s information safe and free from fraud. While all this history is educational to be sure…let’s move on to the topic at hand, how to get and use credit cards in today’s society. Here’s everything you need to know:

How to Get a Credit Card?

Before looking at credit card fees or benefits, we will look at how you can go about getting a credit card in the first place. Most credit card companies require a good credit history before they will issue credit in the form of a credit card. The credit requirements vary for each company. The best credit cards, offering the greatest reward deals and such, are often hard to qualify for unless you have years of aboveboard payment history to showcase.

Other types of credit cards are designed for those with little, none, or bad credit. However, generally, most all credit card companies demand at least a credit score of 650 in order to issue a card, though some will go as low as 550.

Keep in mind, credit cards that will allow you to get a line of credit with a lower credit score often have extremely high interest rates and won’t usually offer many rewards, so be careful if your credit is less than ideal.

Since your credit score is such an important factor when it comes to getting a credit card, it’s important to understand what goes into building that number. Your credit score is based on the following:

Your credit history.
Your payment habits, such as if you make payments on time.
How much debt you already have, which determines your debt utilization ratio. Ideally, you don’t have several credit cards, all maxed out.

What if Your Credit History isn’t Great?

Thankfully, there are some ways to boost up your credit if you simply don’t have much history to speak of by getting a secured credit card from your bank, applying for a store credit card or even getting a loan from your bank. This is worth the effort because once you get your credit score to 650 or higher, you can apply to many types of credit cards, some with insanely good introductory rates, like 0% APR or those with unlimited cashback options or more. To help you understand how to go about doing this, we will look closer at one of these options, the secured credit card.

What is a Secured Credit Card & How Does it Work?

A secured credit card is a great way to build credit up to what is considered good that being a score of 650 or higher. It is an especially great way to build credit from nothing, meaning you are starting from scratch. In fact, if you have never had a line of credit, either from a student or car loan, it might be the only way to build your credit. Of course, if you have had loans before but have damaged your credit through missed payments or other financial mistakes, you can also use them to rebuild your credit.

A secured credit card is basically a line of credit that is backed with a cash deposit. This means you open a secured credit card with a bank, depositing a set amount, which becomes your line of credit. For example, you could deposit $500, and then you will have a credit limit of $500. You then use your secured credit card and pay it off as you would any other card on a monthly basis. Eventually, this will build your credit by showing a payment history, allowing you to successfully apply for a regular or unsecured credit card.

Credit Card Payments: How do They Work?

Most credit cards work the same way, meaning you pay your bill monthly on a set day each month. Usually, payments come due about two to three weeks after the billing cycle ends. Credit cards require you to pay at least the minimum amount due. This amount is tabulated using your current balance. In most cases, your minimum payment amount will be around 2 to 4% of the total balance on your card. Paying the minimum amount on time is necessary to avoid late fees and credit damage. If you worry about paying your bill on time, you can set your payment to automatically deduct from your checking account. Of course, you want to make sure you have adequate money in your account to cover the bill to prevent a bank overdraft fee. To avoid accruing interest charges at all, pay the full balance due, not simply the minimum payment amount.

Perhaps, the most important aspect to understand about credit cards is that you should never charge more on your credit card than you are able to pay in full at the end of the month. If you only make the minimum payment, you can fall into the trap of spending more than you can afford to pay and quickly get in over your head once interest charges start adding up.

Credit Card Interest: How Does It Work?

To avoid credit card interest, pay off your balance in full each month. If you don’t, you have to deal with credit card interest, which is usually anywhere from 12-28% APR. APR means annual percentage rate. To understand how an APR works, consider the following:

If you have a 28% APR and keep a balance on your card of $1000, you will have paid $280 in interest charges in years’ time. The APR is divided into 12 months. So, in each billing cycle, you will pay 1/12 of the annual rate. As another illustration of how this works, let’s assume you have an APR of 25%. That means if you have a $1,000 balance each month, you will pay 1/25^th of that amount or 2.01% monthly, which would equate to $21 of interest monthly.

Keep in mind that even when you pay on your balance, if you do not pay off the amount in full, you will still accrue interest overtime. For example, if you have a $1,000 balance and make only the minimum payment of $58, your $58 payment will only pay $37 of your balance, the rest will go towards interest. So, paying off your amount in full is always best!

Other Credit Card Fees

Interest rates and late fees for nonpayment are not the only fees you have to deal with when using a credit card. Other fees can include annual fees, which is the yearly price you pay to use the card. Some cards don’t have an annual fee, others can be pricey and cost up to $250 yearly, such as those found on cards with great perks and good travel rewards. The average annual fee is around $95. Although you can obviously opt for credit cards with no annual fees, often the cards that do have a fee are worth having simply for the rewards they offer. You just have to do the math in terms of whether the rewards are enough to merit the annual cost.

Credit cards also charge a balance transfer fee. You often notice this when transferring the balance on one credit card to another. In most cases, balance transfer fees are around 3-4%. It can be worth paying that fee if transferring your balance will mean you owe less interest overall, such as when you transfer a balance from a high interest rate credit card to one with a lower rate. Finally, the last fee you might have to pay when using a credit card is the cash advance fee. This means you borrow from your credit limit. Usually, this fee is around 5%.

Why Use a Credit Card?

After reading about all the fees and the cost of using a credit card, you might wonder why you should even bother. Is it even worth it to use a credit card? Well, yes. We believe if you use your credit card wisely, they can be an extremely convenient way to pay. You can also use rewards to reduce travel costs by unlocking airline miles. The cash back rewards on credit cards can also be advantageous. Other benefits include bonuses like trip cancellation insurance and car rental insurance. You can even get a business credit card if you are a new entrepreneur trying to get a business up and running successfully. Such cards can be immensely useful in creating cash flow.

With the risk of fraud being so great today, credit cards also offer a measure of safety when it comes to purchasing items online. Since your credit card account isn’t directly linked to your banking account like your debit card, it is safer to use online. In addition, many credit card companies provide protection to their customers, allowing them to dispute fraudulent charges. You can even set up alerts or various other safety features that will ensure no one ever uses your card to make extravagant purchases without your knowledge and permission.

Bottom Line

Hopefully, the information above has helped you determine if a credit card is a tool you want to utilize or is better off avoided. If you use them responsibly and pay your balance off each month, they are extremely helpful and beneficial. Of course, if you overspend, overextend, and carry a balance that accrues high interest, they can get you in more trouble than they are worth. Therefore, you must determine for yourself if you want to use the credit card wisely and benefit from its features or avoid it as a way to protect yourself from overspending. No one can make that determination for someone else.