How do credit cards work? 

Whether you’re new to the world of credit card rewards or you have several credit cards, you’re likely visiting The Points Guy because you want to know more about how credit cards work. In this article, we’ll start at the beginning and walk through some credit card basics.

What is a credit card?

A credit card is a physical card made of plastic or metal that allows you to make purchases using borrowed funds. A credit card is different from a debit card, which draws from the existing funds in your bank account. Credit cards also accrue interest on the amount of money you borrow, which kicks in if you don’t repay the full balance on your card before the monthly due date.

Credit cards are closely connected to your credit score, an indicator of how well you manage your credit obligations. The better your payment history (among other factors), the higher your credit score. Depending on your overall financial situation, with a strong credit history, you may be eligible for more premium credit cards, which allow you to earn reward points as a percentage of your spending. Premium credit cards also come with higher limits and other valuable perks.

How do credit cards work?

Credit cards allow users to borrow any amount of money, up to their credit limit, repeatedly over an indefinite period. As long as your account remains in “good standing” with a good payment history, it will stay open. If you’re unable to pay off your full credit card balance — which we always recommend — you must at least make a minimum monthly payment to avoid incurring late fees. The average annual percentage rate, or APR, on credit cards is over 20%, so carrying a balance and allowing your debt to accumulate can lead to significant costs over time. It’s important to be mindful of this to prevent your debt from snowballing, which can lead to a decrease in your credit score.

How does credit card interest work?

Credit card interest is stated as an APR, and reflects the total annual cost of borrowing, expressed as a percentage. Credit cards can charge a few different types of APR, but the most common one is what’s called purchase APR. The purchase APR of your credit card is the interest rate that applies to purchases — in other words, the standard interest rate. Being mindful of the purchase APR is essential for managing your credit card balance and minimizing your borrowing costs. To find your APR, review your credit card statement or access your account online. Other types of credit card APR include cash advance APR (the amount of interest charged on cash advance transactions) and penalty APR, which is a higher APR rate that may be charged if you exceed your credit limit or miss payments.

How do credit card payments work?

Credit card companies typically provide four options for paying your monthly credit card bill: making a minimum payment, paying the statement balance, paying the current balance, and paying a custom amount. The minimum payment is, as you might have guessed, the minimum amount you must pay to allow your account to remain in good standing. The statement balance is the total of your charges during the last billing cycle. The current balance consists of the total amount spent to date (in other words, the amount you’ve spent since your last payment, minus any recent charges still pending). You can also pay any amount you like in between (custom amount).

What are the different types of credit cards?

There are different types of credit cards to choose from, but here are some of the most common card categories.

General travel cards: General travel credit cards earn rewards toward future travel and offer travel perks that aren’t tied to any one airline or hotel brand. These rewards are typically transferable and highly flexible. Common travel card perks include complimentary travel insurance, TSA PreCheck and Global Entry credits, and airport lounge access.

Airline cards: Airline credit cards are tied to a specific airline and earn rewards in the form of that airline’s points or miles currency. You’ll also enjoy perks like free checked bags, automatic elite status, and airport lounge access.

Hotel cards: Hotel credit cards are tied to a specific hotel brand and also earn rewards in the form of loyalty program points, which you can use for any hotel within that brand. You can get perks like free nights and automatic hotel elite status.

Cash-back cards: Cash-back credit cards allow you to earn a percentage of your purchase in the form of cash back. You can then redeem your cash rewards, usually as a statement credit. Some cash-back cards come with other valuable perks, such as complimentary insurance coverage, discounts, and access to exclusive offers.

Secured cards: Secured credit cards are designed for those with limited credit history or a low credit score. With a secured card, you’ll be required to provide a security deposit when you open the card, which acts as collateral for the card issuer. Secured credit cards typically don’t earn rewards but are a great way to build (or rebuild) credit history.

Business cards: Business credit cards can help business owners manage their business operations. With a business credit card, you can separate your business and personal expenses, provide employee cards to members of your team for convenience, and earn valuable travel and other rewards on your business spending.

Student cards: Last but not least, student credit cards are designed to help college students build credit and create strong financial habits. Like secured cards, student credit cards earn minimal rewards but are a great option for young people to ease into the world of credit cards.

How to choose the right credit card

The best credit card for your wallet will depend on your personal spending habits and financial goals. Odds are, whether your goal is to build credit, earn cash back, or travel rewards, there’s a card that fits your strategy. Start by considering what you hope to accomplish by getting a credit card. Then, you can narrow down your choices and apply for a credit card that best meets your needs.

Bottom line

Credit cards, especially rewards credit cards, can seem complex and downright daunting. However, by understanding how they work, you can find the card that will help you manage your spending and move closer to your financial goals. Just remember to use your credit card responsibly by avoiding overspending and doing your best to always pay the balance on time and in full.

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