Credit cards allow you to make purchases and pay for them over time. They can be a useful financial tool if used responsibly. However, credit cards come with risks, fees, and the potential for debt. This beginner’s guide to understanding Credit Cards covers the key things you need to know about credit cards.
What is a Credit Card?
A credit card is a payment card issued by a financial company that lets you borrow funds to pay for purchases. The credit card company pays the merchant upfront and you repay the money you spent plus any interest or fees over time.
Credit cards allow you to:
- Make purchases without needing cash on hand
- Pay over time through monthly payments
- Earn rewards like cash back or travel points
- Build credit history when used properly
They differ from debit cards in that you are borrowing money rather than using your own funds. Credit cards also allow flexibility in repayment that debit cards do not.
How Do Credit Cards Work?
When you use a credit card to make a purchase, the credit card network communicates with the merchant and your bank to authorize the transaction. Here is what happens behind the scenes:
- The merchant runs your credit card through their point-of-sale terminal.
- The merchant’s bank sends details about the transaction to the card network, like Visa or Mastercard.
- The network requests authorization from your bank, ensuring you have available credit.
- Your bank puts a hold on your credit line for the purchase amount and approves the transaction.
- The network gives the thumbs up to the merchant, who completes the sale.
- Your bank pays the merchant’s bank and posts the transaction to your account.
- You get a monthly statement detailing charges to pay back over time.
This entire process happens in seconds! The network acts as the middleman facilitating communication between merchants, their banks, and your bank.
READ ALSO: What is a Credit Card Balance: Understanding Their Significance and Best Practices for Management
Types of Credit Cards
There are many types of credit cards available. Some common categories include:
Rewards Credit Cards – Offer points, miles or cash back when you use the card. Great for spending you already planned on. Be sure to pay off the balance each month.
Travel Rewards Cards – Earn free flights, hotel stays, or upgrades through travel loyalty programs. Best for frequent travelers.
Cash Back Cards – Get a percentage of purchases back as cash rewards or statement credits. Good for everyday spending.
Balance Transfer Cards – Special offers like 0% intro APR help consolidate and pay off debt faster by transferring existing balances from other cards.
Business Credit Cards – Provide benefits like employee cards and spending insights for business owners. Rewards programs cater to business spending.
Secured Credit Cards – Require a refundable deposit to access a line of credit. Help build credit from scratch.
Student Credit Cards – Starter cards to help college students build credit history at a younger age if managed prudently.
Charge Cards – Must be paid off in full every month rather than carrying a balance. Often include luxury travel perks.
Applying for a Credit Card
When applying for a credit card, the issuer will check your credit report and score to determine if you qualify. Here are some steps in the application process:
- Pre-qualification – Pre-qualify to get an initial sense of what cards you may be approved for. Soft credit checks that don’t affect your score are used.
- Comparing cards – Based on your credit and finances, compare different cards and their features to find the best fit.
- Formal application – Submit a full application with a card issuer, which will do a hard credit inquiry. Provide info to verify income, employment, etc.
- Approval (or denial) – The issuer will approve or deny your application and notify you of their decision. Approval terms like credit limit will be communicated.
- Accepting terms – If approved, you’ll receive cardholder documents. Read all terms and conditions before accepting the offer and activating your new card.
Be sure to compare multiple cards to find the best one for your spending habits and financial situation.
Credit Card Terms and Conditions
Here are some key credit card terms and concepts you’ll come across:
- APR – The annual percentage rate is the interest rate charged on unpaid card balances. This rate can be variable or fixed.
- Intro APR – Many cards offer a 0% promotional rate for a set period of time on purchases or balance transfers.
- Credit Limit – This is the maximum you can charge on the card, set based on your creditworthiness.
- Minimum Payment – The minimum amount due on your monthly statement, usually around 2-3% of the balance.
- Grace Period – The interest-free time between when a purchase is made and its due date, usually around 21 days.
- Foreign Transaction Fee – A fee charged on transactions processed in a foreign currency, often 3% of the transaction amount.
- Annual Fee – A yearly fee charged for having the card, common on premium rewards cards. Waived for some users.
It’s essential to understand these key terms before agreeing to a credit card. Ask questions if any aspect is unclear.
Maintaining Good Credit Card Habits
Using credit cards responsibly is key. Here are some tips:
- Pay on time – Payment history is the biggest factor in your credit score. Avoid late fees by paying at least the minimum due each month.
- Pay off monthly – Pay your statement balance in full each month to avoid costly interest charges.
- Mind your limits – Keep your balance well below your credit limit to maintain a low credit utilization ratio.
- Create a budget – Know how much you can realistically pay off each month. Don’t overspend.
- Set up autopay – Automating payments helps avoid missed due dates that harm your credit score.
- Review statements – Routinely check statements for fraudulent charges or billing errors. Report issues immediately.
- Increase your credit – Request credit line increases over time to keep utilization low as your finances improve.
Following credit card best practices leads to a higher credit score and saves money on interest.
Hidden Hazards of Credit Cards
While credit cards offer convenience and rewards, it’s also critical to watch out for risks like:
Paying only minimums – This results in more interest paid over time and ballooning debt. Pay off statement balances when possible.
Late fees – A late fee, often $30-40, is charged if payment is received after the due date. Set up autopay as a backup.
Foreign transaction fees – Using your card abroad means paying an extra fee, usually 3% of the transaction amount. Use a card with no foreign fees instead.
Cash advance fees – Withdrawing cash from your credit card at the ATM means paying a cash advance fee plus a higher interest rate. Avoid it when you can.
Going over the limit – Exceeding your credit limit leads to penalty fees and other problems. Know your limit.
Opening too many new cards – Each card application results in a hard credit inquiry, which can temporarily lower your score if done excessively. Apply sparingly.
Not reviewing statements – Mistakes happen. Not reviewing your statement means missing errors or fraudulent activity. Check monthly.
Being aware of these hazards lets you proactively avoid fees, overspending, and other issues.
READ ALSO: Maximize Travel and Cash Back with the Best Rewards Credit Cards
How Paying with Credit Cards Works
Using your card to make purchases is easy. Here is a typical transaction process:
- Present your credit card when it’s time to pay. The merchant runs the card through their point-of-sale terminal.
- The terminal connects to the card network to authorize the purchase and verify you have available credit.
- Once authorized, you sign the merchant’s receipt or enter your card PIN. For online or recurring purchases, providing the card number is sufficient.
- The funds are transferred from the card issuer to the merchant’s bank account within a day or two.
- The transaction appears on your next credit card statement as a purchase along with its date, merchant name, and amount.
- You then repay the amount owed before the monthly due date based on the card’s terms.
Some key things to know when paying with plastic:
- Chip cards are more secure than old magnetic swipe cards. Keep card info protected.
- Know your daily spending limit – don’t go over the single purchase max.
- Save receipts to cross reference charges on your statement.
- For big purchases, consider using a rewards credit card to earn points or cash back if you’ll pay it off monthly.
- Be cautious using your card online. Only provide details on secure sites.
Using credit cards in stores, online, over the phone, and for recurring payments is quick and convenient as long as you take basic security precautions.
How Credit Card Rewards and Incentives Work
Many credit cards offer rewards programs to entice people to use their card. Here are some common examples and how they work:
Cash Back – Get 1-6% of purchases back in the form of statement credits, check, or gift cards. Great for frequent spending.
Points – Earn points per dollar spent that can be redeemed for travel, merchandise, gift cards, and more. Valuation varies.
Miles – Frequent flyer miles can be earned and used to book award flights and hotel stays. Best for jetsetters.
Insurance – Cards often include rental car, travel, and purchase insurance when you use the card to pay. Verify policy details.
Discounts – Special offers like 5% off at partner merchants when you use your card. Compare to get the best deals.
Free Gifts – Sign-up bonuses like 50,000 points after meeting minimum spend requirements. Factor bonuses into your comparison.
The value of rewards varies greatly depending on the card. Compare redemption values and ensure the annual fee is justified. Pay off monthly.
Tips for Choosing the Best Credit Card
With hundreds of credit cards on the market, choosing one can feel overwhelming. Here are some tips for picking the best card:
- Review your credit report and target cards you’re likely to qualify for based on your credit score.
- Consider your typical spending categories and look for a card that aligns with your habits and earns the most rewards.
- Compare sign-up bonuses across cards – some offers can be quite generous.
- Do the math on points and miles earnings using a rewards calculator to estimate potential value.
- For travel cards, research the loyalty program benefits and airline/hotel transfer partners carefully.
- Check out-of-pocket costs like annual fees – are perks worth the price?
- Consider foreign transaction fees if you travel internationally.
- Look for 0% intro APR offers if consolidating debt.
- Optimize cards already in your wallet before applying for new ones to avoid credit score damage.
Picking a card that matches your spending profile and credit history offers the most benefit.
Impact on Your Credit
Used prudently, credit cards can help build your credit score over time. But they can also damage your credit if managed poorly. Here are some factors to be aware of:
On-time payments – Pay at least the minimum due each month. The payment history category heavily influences your score.
Credit limits – Using more than 30% of available credit hurts your score. Ask for a higher limit as your score improves.
Credit inquiries – Applying for several new cards at once results in hard inquiries that temporarily lower your score.
Credit history – Keeping your first card open is useful for having a longer credit history, which helps your score.
Defaults – Not paying your card balance leads to serious credit damage and collections. Avoid at all costs.
Credit mix – Having different types of credit (credit cards, loans, etc) leads to a higher score.
Making payments on time and keeping balances low relative to limits are essential credit card habits for maintaining a strong credit score. Monitor your reports.
Credit Card Safety Tips
Your credit card comes with inherent risks. Follow these tips to use it safely:
Guard your card details – Don’t let anyone else use your card. Never share card numbers except when making a purchase yourself.
Watch out for skimmers – Data-stealing skimmers attached to ATMs and gas pumps put your info at risk. Pay inside if you can.
Shop secure sites – Look for “https” URLs and padlock icons when shopping online. Avoid public Wi-Fi for purchases.
Review statements closely – Identify and report any unauthorized charges promptly to limit liability for fraud.
Set up account alerts – Ask your issuer to alert you for suspicious activity, overspending, missed payments, etc.
Shred documents – Discard old statements, expired cards, and convenience checks securely to prevent identity theft.
Monitor your credit – Check reports regularly for inaccuracies that could indicate fraud. Consider credit monitoring.
Being aware of risks allows you to take preventative measures to avoid credit card fraud. Report lost or stolen cards immediately.
Credit Card Mistakes to Avoid
Those new to using credit cards should be on the lookout for these common mistakes:
Paying late fees – Set up autopay so your bill gets paid on time every month. Late fees quickly add up.
Going over the limit – Avoid over limit fees by knowing your credit limit. Ask for an increased limit once your score improves.
Using the card for everything – Just because you have a credit line doesn’t mean you should max it out. Stick to purchases within your budget.
Failing to comparison shop – Don’t get stuck with a card that doesn’t offer the rewards or perks you want. Compare thoroughly.
Not redeeming rewards – Don’t let points and miles expire! Redeem them for statement credits, flights, or other options regularly.
Applying for too many cards – Every application results in a hard inquiry. Apply conservatively to avoid credit score damage.
Cancelling old cards – Keeping your first card open preserves your credit history length. Downgrade vs. cancelling.
Avoiding these missteps lets you maximize credit card benefits and rewards while protecting your credit standing.
To Recap
Getting your first credit card is an important milestone. Used wisely, credit cards provide convenience, flexibility, rewards, and the ability to build your credit standing for the future. But beware of high interest costs by paying off monthly, and avoid traps like late fees or credit damage.
Do your research, compare multiple cards, understand key terms and conditions, and cultivate excellent money management habits. While credit cards make it easy to overspend, their many benefits can be realized through education, discipline, and responsible practices.
Equipped with this beginner’s guide to credit cards, you now have a solid foundation of knowledge. Apply for your first card conservatively, use it prudently, and credit cards can work for you rather than against you.
Frequently Asked Questions About Credit Cards
How do I choose my first credit card?
For your first card, opt for a student credit card if you’re in college or a secured card if you don’t have established credit. Review cards for fair credit that don’t charge an annual fee. Using your first card responsibly helps build credit.
How many credit cards should I have?
One or two cards are sufficient for most people. Having too many cards means managing multiple statements and due dates. However, it can make sense to have a card for revolving spending, one for groceries or gas, and one for dining or travel depending on your habits.
Is it bad to close a credit card?
Closing a card can shorten your credit history length and increase your credit utilization ratio, both of which hurt your score. Avoid closing your first card. Instead, consider downgrading to a no annual fee card rather than cancelling outright.
What’s the easiest credit card to get approved for?
The easiest cards to get approved for are secured credit cards, student cards for those enrolled in college, and cards designed for those trying to build or rebuild credit. Focus on options with no annual fee. Comparison shop for the best terms.
Do multiple credit card inquiries hurt your credit?
Too many hard inquiries in a short span can temporarily ding your credit score. However, multiple inquiries from auto, mortgage, or student loan shopping within a focused period count as one inquiry. Avoid applying for several credit cards at once.
Should I pay off my credit card every month?
Paying your monthly statement balance in full is ideal to avoid interest charges. However, for large purchases, cards with 0% intro APR periods can make sense for giving you time to pay it off without interest. Don’t make purchases you can’t realistically pay off.
Can credit cards be used to build credit?
Yes, using a credit card responsibly by paying on time and keeping your utilization low can build your credit profile. Avoid cards with annual fees. While you don’t need to carry a balance, keeping the account open long term aids your credit through the average age of accounts.
In another related article, The 10 Best Credit Cards for Small Businesses in 2024
