Credit cards

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How do credit cards work?

Credit cards are a form of revolving credit. This means they let you borrow money up to a predetermined limit, called your credit limit or spending limit.

Credit cards can be useful tools for giving you more spending flexibility, building your credit, and even budgeting, but they can also cause you to go into debt if you’re not careful.

Everything from bills to online or in-person purchases can usually be paid for with a credit card, and credit cards are accepted by merchants all over the world. Whatever money you spend on your card becomes your balance or the amount you owe. You’re responsible for paying this debt back in full eventually, but the entire balance isn’t due right away.

Credit limits

This is the maximum amount you can borrow each spending period and it resets every time you pay off your balance. So if your credit limit is $10,000 and you spend $6,000, you can spend up to $4,000 more. Once you’ve paid back whatever you’ve borrowed, you can spend up to $10,000 again.

When you apply for a credit card and get approved, the issuer will tell you what credit limit you’ve been approved for. This limit is determined by things like your credit score, borrowing habits, income, and debt. You’ll have a separate limit for each of your credit cards and an overall limit that combines all of your credit lines.

If you have other credit cards, you’ll likely be approved for less each time you apply for a new card as your overall limit increases.

Minimum payments

Every month or statement period, you’ll be required to make at least a minimum payment toward your debt. The minimum monthly payment is determined by the total amount you owe. So the higher your balance, the higher your minimum. Usually, minimums are in the $20 to $30 range or equal to about 2% of your balance.

But this is where things get tricky. Just because you can get away with paying just the minimum doesn’t mean you should. We don’t recommend carrying a balance if you can avoid it.

Carrying a balance

When you “carry a balance,” you leave money on your card from one month to the next instead of paying it off. At the end of each billing cycle, you’ll receive a credit card statement that shows your statement balance and payment due date.

Your statement balance is how much you borrowed for the previous statement period plus any interest or fees you might have been charged. Your payment due date tells you when you’re required to make your minimum payment. The majority of cards will give you a grace period of around 20 days to get your payment in before charging interest.

If you don’t pay off your statement balance each billing cycle, you’ll start owing interest on your outstanding debt. Then, you have to pay this on top of what you’ve already borrowed, and you’ll continue collecting more interest the longer you take this balance with you.

So even though making just your minimum payment every month is allowed, it’ll take you longer to get out of debt, bring down your credit score, and cost you a lot in interest.

Credit card interest

How much interest you pay when you carry a balance depends on your card. Every credit card will have an Annual Percentage Rate or APR range for all of its customers, and you’ll be approved at a certain rate when you get your card.

As a rule, you need a decent income and a great credit score to qualify for the best, lowest rates. Most people can expect a rate starting at about 20%.

Read more: Credit card interest calculator

Missing payments and late fees

Each time you miss a payment due date, you’ll be charged a late fee (some credit cards waive the first one). Usually, this is equal to around $30 or $40 each time.

Missing payments also put your account and credit at risk. Your account is only considered to be in “good standing” as long as you’re making payments on time. Missed payments can not only hurt your credit but give your card issuer the right to close your account. And if they don’t, they’ll more than likely raise your interest rate.

Missed payments can also end up on your credit report if you’re more than 30 days late. This can bring your credit score down significantly and stay on your report for up to seven years.

Credit cards vs debit cards

Although credit and debit cards look the same when swiping at the grocery store, the two payment methods are different in almost every way. Here are just a few.

Debit cards don’t let you borrow – For the most part, debit cards only let you spend money you already have. They’re linked directly to a checking account and you withdraw from this each time you pay for something. While it’s possible to spend more than you have in your checking account with your debit card, you’ll pay overdraft fees and over-limit fees each time you exceed your balance. And if you don’t pay back what you owe, your transactions can be declined and your account closed.

Debit cards don’t build credit – Debit cards don’t require a credit check to get and don’t affect your credit score. This is because your debit card activity isn’t reported to the credit bureaus and won’t count for or against you. Credit cards do report your activity – including your credit use and payment history – and can positively or negatively impact your credit. They almost always have minimum credit score requirements when applying.

Debit cards are linked to a checking account – Debit cards come with almost every checking account. This provides you with easy access to the cash in your checking account so you can make purchases instantly using the money you have in the bank. Credit cards stand alone. You use them to borrow cash and pay what you borrow back from a linked account, but they don’t withdraw directly from a bank account.

You’ll often see us recommending that you use your credit card as if it’s a debit card, meaning you only spend money you know you have in the bank and pay back your balance right away. This is a responsible way to use your credit card — it can help you avoid going into debt or paying interest and combine the protection of a checking account with the rewards and benefits of a credit card.

Credit cards vs loans

Credit cards give you revolving credit, which is not the same as taking out a loan.

Loans usually pay you all the money you need to borrow upfront and give you anywhere from six months to twenty years or more to pay it all back in regular payments. Credit cards give you a credit limit and allow you to borrow up to this limit indefinitely. You can spend this much then pay it all back and repeat for as long as your account is open and you’re making the minimum monthly payments.

Both credit cards and loans require credit to qualify. And for both, good credit will get you better interest rates and the option to borrow more money. But as a rule, credit cards charge higher interest rates than most loans.

Credit cards tend to be the better option overall for short-term borrowing while loans are the better option for long-term borrowing.

Pros and cons of credit cards

There are a lot of perks of using credit cards in your everyday life. From helping you improve your credit to giving you a convenient payment method you can use anywhere, there are so many reasons to love these cards.

Pros

Here are just a few of the good things that come with credit cards.

Credit building

Like it or not, you need credit for most things you might want to do with your money. Taking out a mortgage, buying a car, and opening a loan all require credit.

Every time you try to borrow money or apply for credit, a hard credit pull or inquiry is performed. This is a thorough check of your credit history designed to determine if you repay your debt. If you have poor credit, lenders can reject you automatically after this check. Unfortunately, bad credit can make your life infinitely more difficult. While it’s possible to find credit cards that will approve applicants with bad credit, they are likely to offer limited benefits and to be very expensive to use.

While you can technically get by without a credit card and still work your way up to a good credit score, credit cards make it much easier to build credit every day just by going about your life making everyday purchases and paying back what you borrow. All credit card companies report your activity to the credit bureaus, so your repayments and spending show up on your credit.

More safety than debit cards or cash

Credit cards have safeguards in place to prevent fraud, hacking, and unauthorized purchases, making them more secure than debit cards or cash.

The vast majority of credit cards offer a base level of fraud protection that ensures you’ll never have to pay for purchases you don’t authorize. This is often called a zero-liability policy. Because they’re not linked directly to a bank account, credit cards provide a buffer for your money so a person can’t steal your credit card and immediately steal from you. You have time to contact your bank and get the charges reversed.

Benefits and rewards

Cash back, points, and travel rewards are free money. And on top of these, many cards also come with complimentary services, statement credits, and benefits that can be worth anywhere from hundreds to thousands of dollars annually.

It’s definitely worth getting to know your card’s unique set of benefits and rewards program so you know all the things you can get for free. If you choose cards with programs that complement your spending habits, you can save serious money.

Travel convenience

Credit cards are perfect for travel because they’re accepted almost everywhere. This is a whole lot easier than converting your money to the local currency every time you need to travel or keeping a wad of cash on you, not to mention much safer.

Just watch out for foreign transaction fees, which are charged when you make international purchases or buy from merchants based abroad. Many credit cards charge foreign transaction fees equal to around 3% of each purchase, but a lot of cards – especially those designed for travel – waive them. If you do a lot of travel, consider a no foreign transaction fee credit card.

Cons

For all the ways credit cards can make our lives easier, they can also get us into trouble. Or rather, we can get ourselves into trouble with how we use our cards. Here are some disadvantages of credit cards. Particularly, using them irresponsibly.

Risk of debt

By design, credit cards let you spend money you don’t have. This makes it easy to overspend and rack up debt because you aren’t required to pay back what you borrow right away (even though this is a great idea).

Before taking out your first credit card, you should have a plan for staying on top of your payments and keeping your debt under control.

Late fees and interest

Late fees and interest go hand-in-hand with credit card debt. If you get into a habit of missing your payments and waiting to pay off your balances, you’ll pay for it – literally.

But of course, there are things you can do to avoid late payments. Scheduling automatic payments (for the statement balance), for instance, is a good way to be sure you never miss a payment. There are also plenty of personal finance apps that can help you keep track of your credit card balances and due dates.

Credit damage

If you use your credit card responsibly by making your payments on time and paying off your balance in full, your credit will improve over time. But if you miss payments, carry a balance, or always max out your card, your credit score will take a hit.

And unfortunately, it can take a while to repair your credit, but it is possible.

Fraud

Although credit cards offer many protections against fraud — such as account monitoring and real-time alert systems — it can still happen.

But credit card fraud is less common than other types of fraud and less risky to cardholders.

If you ever think there’s even the slightest chance that your card or account has been compromised, act quickly. There’s usually a short window of time you have to dispute fraudulent charges and have the payments reversed. Take advantage of account alerts, fraud monitoring, and other protections included for free with many credit cards.

Your card issuer will notify you too if they spot suspicious activity on your account such as large payments occurring in a location far from home for you. But it’s also up to you to keep an eye on your activity and speak up right away if something seems off.

Types of credit cards

This is not a comprehensive list of all the different types of credit cards that exist, but it can help give you an idea of the main categories.

Secured vs. unsecured credit cards

If you’re brand new to credit cards, choosing between a secured and unsecured credit card is one of the first things you should do.

Secured credit cards require a security deposit as collateral, and use the amount of money you deposit as your credit limit so you can’t borrow more than you’ve provided. If you’re not able to repay your debt, the issuer will keep your deposit. But if you make your payments, you can get your deposit back if you close your account. Secured cards tend to have fairly low credit score and income requirements and more limited rewards.

Unsecured credit cards do not require collateral, meaning you don’t have to deposit any money when applying. This makes them riskier for lenders, so issuers will require a higher credit score and income as proof that you have the experience and means to repay your debt. Compared to secured cards, unsecured cards offer much higher credit limits and more robust rewards.

Rewards credit cards

There are many different types of reward cards, but the two main ones are:

General rewards credit cards
Travel rewards credit cards

Let’s break these down.

General rewards credit cards

Rewards cards can earn either cash back or reward points. Cash back is calculated as a percentage of each purchase – for example, 2% cash back or 2% of a purchase total – but reward points are more complicated. They’re calculated as a certain number of points per dollar where 2x points equal two points per dollar.

The value of each reward point isn’t always clear. This is because credit card companies don’t often advertise what their points are worth and different redemption options can make a point more or less valuable. Depending on the card and how you decide to redeem, each point could be worth far less than a cent or up to five cents.

Within the category of rewards cards, there are flat-rate rewards cards that earn a set amount on all qualifying purchases – such as 1.5% cash back on everything – and there are category cards with bonus categories that either rotate every month or quarter or that you need to activate. For example, bonus categories might pay you a higher rewards rate for drugstore purchases and spending in grocery stores one month, then restaurants or gas the next.

Both cash back and points can usually be redeemed as a statement credit to lower your credit card bill. This is usually the most basic option. You might also be able to use them to purchase travel, shop, or buy gift cards. Compare all your choices before redeeming to try to get the most value out of your earnings.

Travel rewards credit cards

To earn miles instead of points, you would choose a travel rewards credit card. These earn the most reward miles when you use your credit card to purchase travel and fewer miles when you use it for anything else.

For example, you might earn five miles per dollar for every purchase made through a travel portal like Capital One Travel or Chase Ultimate Rewards and only one mile per dollar on all other purchases. Some people choose to use their travel cards all the time because they want travel rewards and other people choose to use their travel cards only when purchasing travel. What makes the most sense for you depends on how often you fly and stay in hotels.

Miles can be redeemed for flights, hotel bookings, and more. They can almost always be transferred to brand partners as well if you’d rather convert them to membership rewards points (maybe you’re close to premier status with your favorite loyalty program, for example).

Like rewards points, the value of a mile depends on the specific credit card. If you like “travel hacking,” or using your credit card to score deals on travel, you might compare a few redemption options to see which one offers the most bang for your buck. To paint a picture of what this might look like, you might plug in your points to see if transferring your miles to a particular airline is enough to score a free first-class ticket or if booking directly through the travel portal for your card offers better deals.

Many mid-tier and premium credit cards also come with extra perks and bonuses like hotel credit, travel insurance, purchase protection, and free access to different subscriptions and services (like CLEAR for a faster airport check-in).

Branded credit cards

Branded credit cards are associated with a particular brand such as a hotel, airline, or store. These cards often earn the most rewards for purchases made within their brand but can usually be used anywhere just like a regular credit card. Usually, branded cards are rewards cards that earn membership rewards points for a specific loyalty program.

You might choose a branded credit card over a general credit card if you’re loyal to a particular brand or company. For example, if you always choose Hilton hotels when you’re traveling, a Hilton Honors credit card from American Express might make sense. Instead of cash back or miles, these cards earn Hilton Honors Bonus Points for your Hilton Honors account. These membership rewards points can be used for award nights, room upgrades, services, and amenities at Hilton properties.

Just note that with branded rewards cards, point value can vary based on the brand and program. For example, a Marriott Bonvoy loyalty point might be worth slightly more than a Hilton Honors point because Marriott doesn’t require quite as many points for award nights.

Balance transfer and 0% APR credit cards

A balance transfer card usually includes a promotional interest rate on all qualifying balance transfers made within a set number of months after opening an account. For example, a credit card may offer a 0% intro APR on qualifying balance transfers and purchases made within the first 18 months from account opening. Many people choose to transfer their high-interest debt from multiple cards to one balance transfer card to save on interest while making repayments.

Without a balance transfer credit card or after the promotion period, you will likely pay a very high interest rate if you want to transfer a balance or move debt from another card to this card. 18.99% to 29.99% is a pretty common variable APR range for purchases and balance transfers. Which side of this range you fall on depends on your credit score and borrowing history.

Who should get a credit card?

Credit cards are valuable tools for a lot of people. If you fit any of these descriptions, you might be a good candidate for getting one.

People with great credit scores

If you have a good credit score, you might qualify for the best credit cards. Your score and income will be used to decide if you’re approved or denied, so a great credit score can mean that you pretty much have your pick of cards.

Here’s how FICO credit scores are broken down:

Poor: 300 – 579
Fair: 580 – 669
Good: 670 – 739
Very Good: 740 – 799
Exceptional: 800 – 850

Some of the best, most rewarding credit cards require a very good/great or exceptional/excellent credit score to qualify. These usually come with the most benefits and perks (but also some of the highest annual fees, so keep this in mind too).

People who have their budget under control

If you already have a spending plan that’s working for you and you feel confident in your ability to live below your means, getting a credit card makes a lot of sense. You can use it exactly how you’ve been using your debit card or cash and save money as you go.

Young adults

The sooner you get a credit card and learn how to use it, the easier it is to create good habits and set yourself up for long-term success with your credit.

But you shouldn’t just start with any credit card you like. Choose a beginner credit card for your first one that you know you can qualify for. Beginner cards generally give lower credit limits that are more appropriate for first-time borrowers and are less likely to charge annual fees.

People with no credit history or a poor credit score

You’ve probably heard that you need credit to get credit. But even those who have never borrowed money before or have negative marks in their credit history can qualify for a credit card.

There are many cards you can get approved for with a low credit score. Secured credit cards are an especially good option if you have poor credit either because you’ve never taken out credit before or because you’ve run into issues in the past, like falling behind on your bill payments, that negatively affected your credit.

Who shouldn’t get a credit card?

Credit cards need to be taken seriously, and no one should feel pressured to get one if they’re not ready. Here are just a few types of people that would probably benefit from waiting to apply for a card.

People in severe debt

If you’re already in severe debt, you should probably wait until you have a plan in place to repay that debt before applying for a new credit card. Debt doesn’t have to prevent you from opening a credit card at all, but it should make you think twice about opening credit cards you don’t need and potentially adding to that debt.

Credit cards make it really easy to take on more debt. When you’re struggling to make ends meet and stay on top of your bills and monthly payments, it’s easy to just charge these expenses to your card and tell yourself you’ll pay the balance off later.

But interest, late fees, penalty APRs, and more will only add to the amount you owe and can quickly make it harder to get out of debt.

People prone to overspending

If you already know that you have trouble living within your means and have a tendency to overspend, you probably need to work on this before getting a credit card. Focusing on creating a budget for yourself would be a step in the right direction.

After you’re comfortable with your spending plan and have had practice managing your money and paying off your debt, you can figure out how credit cards can fit into your life in a way that supports your budget.

People who need to borrow a lot of money

Credit cards carry really high interest rates and will penalize you for missing payments. If you need to borrow a lot of money, a credit card is probably not the way to go. You may not get approved for the spending limit you need depending on your credit score and borrowing history, and even if you do, you’ll likely pay more interest than if you were to take out a loan.

Some credit cards offer promotional interest rates like a 0% intro APR for 12 months from account opening, but as soon as this promotion period is up, you’ll need to pay off your balance in full each month to avoid a much higher interest rate (unless you’ve specifically chosen a low-interest credit card).

Personal loans can be a good alternative for larger sums of money and cash advances make sense when you only need to borrow a small amount for a short amount of time.

How to choose a credit card

Credit cards are created to be enticing. They offer shiny perks and rewards that are meant to pull you in, but when choosing a card, it’s important to be realistic.

The first thing you’re going to want to do when choosing a credit card is to check your credit score. This can help you understand what cards you might be able to qualify for and how likely you are to be approved.

You should also check your credit history and look for any “red flags” lenders might be concerned about, such as missed payments or a high credit utilization ratio (or the amount of money you owe divided by your combined credit limit). Basically, if you’re using too much of your current credit, lenders are not likely to want to give you more credit, and this can affect your odds of approval with any card.

After checking out your credit score and history, you’ll want to take a look at your spending habits. This can give you an idea of what benefits you’d actually use. Credit cards should not be aspirational – they should be practical and make your life better right now, without the need to change your spending.

Once you’ve narrowed down your options and know what you’re looking for, you can compare cards side-by-side to see which ones offer the best benefits and perks for you.

How to apply for a credit card

Once you’ve chosen one or two credit cards you’d like to go after, the best thing to do is see if you prequalify. This has no impact on your credit score. Getting pre-approved doesn’t guarantee approval, but it gives you a good idea of if you’ll be approved or denied without adding a hard inquiry to your report.

To check if you prequalify for a credit card, go to the card’s application page. Usually, the prequalification option shows up right next to the “Apply Now” button.

When you’re ready to apply for real, you’ll enter your personal information into an online application and provide details about your income and expenses. You may receive an instant decision after completing the application or you may need to wait a few days for your application to be reviewed.

Be aware that credit card applications always require a hard credit inquiry — also called a hard inquiry or hard pull — to process. Hard inquiries can negatively impact your credit score if you add too many in a short period of time, which sends the message to lenders that you’re short on cash. You don’t ever want to add more hard pulls to your credit report than necessary.

How old do you have to be to get a credit card?

Most credit cards have a minimum age requirement of 18, but that doesn’t mean you can just get any card you want as soon as you’re a legal adult.

New borrowers and young adults need to work on building their credit before they’ll be eligible for the best credit cards, and it’s a good idea to walk before you run. A credit-building card, student card, or secured credit card can help you start your credit card journey off right.

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