Credit Card: What It Is, How It Works, and How to Get One (2024)

What Is a Credit Card?

A credit card is a thin rectangular piece of plastic or metal issued by a bank or financial services company that allows cardholders to borrow funds with which to pay for goods and services with merchants that accept cards for payment. Credit cards impose the condition that cardholders pay back the borrowed money, plus any applicable interest, as well as any additional agreed-upon charges, either in full by the billing date or over time.

In addition to the standard credit line, the credit card issuer may also granta separate cash line of credit(LOC) to cardholders, enabling them to borrow money in the form of cash advances that can be accessed through bank tellers, ATMs, or credit card convenience checks. Such cash advances typically have different terms, such as no grace period and higher interest rates, compared with those transactions that access the main credit line.Issuers customarily preset borrowing limits based on an individual’s credit rating. A vast majority of businesses let the customer make purchases with credit cards, which remain one of today’s most popular payment methodologies for buying consumer goods and services.

Key Takeaways

  • Credit cards are plastic or metal cards used to pay for items or services using credit.
  • Credit cards charge interest on the money spent.
  • Credit cards may be issued by stores, banks, or other financial institutions and often offer perks like cash back, discounts, or reward miles.
  • Secured credit cards and debit cards offer options for those with little or bad credit.

Credit Card: What It Is, How It Works, and How to Get One (1)

Understanding Credit Cards

Credit cards typically charge a higher annual percentage rate (APR) vs. other forms of consumer loans. Interest charges on any unpaid balances charged to the card are typically imposed approximately one month after a purchase is made (except in cases where there is a 0% APR introductory offer in place for an initial period of time after account opening), unless previous unpaid balances had been carried forward from a previous month—in which case there is no grace period granted for new charges.

By law, credit card issuers must offer a grace period of at least 21 days before interest on purchases can begin to accrue. That’s why paying off balances before the grace period expires is a good practice when possible. It is also important to understand whether your issuer accrues interest daily or monthly, as the former translates into higher interest charges for as long as the balance is not paid. This is especially important to know if you’re looking to transfer your credit card balance to a card with a lower interest rate. Mistakenly switching from a monthly accrual card to a daily one may potentially nullify the savings from a lower rate.

Individuals with poor credit histories often seek secured credit cards, which require cash deposits, that afford them commensurate lines of credit.

Types of Credit Cards

Most major credit cards—which include Visa, Mastercard, Discover, and American Express—are issued by banks, credit unions, or other financial institutions. Many credit cards attract customers by offering incentives such as airline miles, hotel room rentals, gift certificates to major retailers, and cash back on purchases. These types of credit cards are generally referred to as rewards credit cards.

To generate customer loyalty, many national retailers issue branded versions of credit cards, with the store’s name emblazoned on the face of the cards. Although it’s typically easier for consumers to qualify for a store credit card than for a major credit card, store cards may be used only to make purchases from the issuing retailers, which may offer cardholders perks such as special discounts, promotional notices, or special sales. Some large retailers also offer co-branded major Visa or Mastercard credit cards that can be used anywhere, not just in retailer stores.

Secured credit cards are a type of credit card where the cardholder secures the card with a security deposit. Such cards offer limited lines of credit that are equal in value to the security deposits, which are often refunded after cardholders demonstrate repeated and responsible card usage over time. These cards are frequently sought by individuals with limited or poor credit histories.

Similar to a secured credit card, a prepaid debit card is a type of secured payment card, where the available funds match the money that someone already has parked in a linked bank account. By contrast, unsecuredcredit cardsdo not require security deposits or collateral. These cards tend to offer higher lines of credit and lower interest rates vs. secured cards.

Credit Card: What It Is, How It Works, and How to Get One (2)

Building Credit History with Credit Cards

When used responsibly, regular, non-secured, and secured cards can help consumers build a positive credit history while providing a way to make online purchases and eliminate the need to carry cash. Since both types of credit cards report payments and purchasing activity to the major credit agencies, cardholders who use their card responsibly can build strong credit scores and potentially extend their lines of credit and—in the case of secured cards—potentially upgrade to a regular credit card.

Building a good credit history is a combination of things—making regular, on-time payments, avoiding late payments, keeping credit utilization under your credit limit, and maintaining a low debt-to-income ratio. By making responsible purchases and paying them off in a timely manner, a credit score will rise, making a consumer more attractive to other lenders. Also, while it's best to pay off your balance each month, your card issuer won't allow you to use another card to do that.

How do I get a credit card if I don’t have any credit?

Building credit history can be a bit of a catch-22. If you don’t have any credit, merchants or banks are less likely to extend credit to you since you’re an unproven borrower. Opening a secured credit card is one of the simplest ways to get started. Since spenders are only borrowing from the money they put down as a deposit, there is little risk for the lender, and it gives them a snapshot of your spending and repayment habits.

Another way to start building credit is to become an authorized user on an established credit account, such as a parent or spouse. The cardholder’s credit history will appear on your account, adding longevity to your credit report. But be sure that the person with whom you partner has good credit habits. If their financial choices are poor, that will also reflect on you.

Do credit cards have fixed or variable annual percentage rates (APRs)?

Many credit cards will have both types of annual percentage rates (APRs). To find out which kind of APR you have, read the cardholder agreement that comes with your credit card. Card issuers must legally disclose what type of APR they have and what it is. If a fixed APR changes, they must also alert consumers of that.

Some credit cards have fixed APRs for purchases but variable APRs for cash advances or late payments. Read the fine print to make sure.

What is a credit card annual fee?

The annual fee on a credit card is the fee charged by the card issuer to extend the credit card to you. Some cards don’t charge an annual fee, but others—most often cards that offer rewards or incentives like cash back—can charge annual fees ranging from $50 to $700.

I am a financial expert with a deep understanding of credit cards and the associated financial concepts. My expertise is backed by extensive knowledge and experience in the field of personal finance. Now, let's delve into the various concepts mentioned in the article:

1. Credit Cards Overview:

  • A credit card is a thin rectangular piece of plastic or metal issued by a bank or financial services company.
  • It allows cardholders to borrow funds to pay for goods and services at merchants accepting card payments.
  • Cardholders are required to pay back the borrowed money, along with interest and any agreed-upon charges.

2. Credit Lines and Cash Advances:

  • Credit card issuers may provide a separate cash line of credit (LOC) for cash advances.
  • Cash advances have different terms, such as no grace period and higher interest rates than regular transactions.

3. Credit Limits and Credit Ratings:

  • Issuers set borrowing limits based on an individual's credit rating.
  • Individuals with poor credit histories may opt for secured credit cards, requiring cash deposits.

4. Types of Credit Cards:

  • Major credit cards include Visa, Mastercard, Discover, and American Express, issued by banks or financial institutions.
  • Rewards credit cards offer incentives like cash back, discounts, or reward miles.
  • National retailers issue branded credit cards, some co-branded with major credit card companies.
  • Secured credit cards require security deposits and are sought by those with limited or poor credit histories.
  • Prepaid debit cards match available funds in a linked bank account.

5. Credit Card Interest and APR:

  • Credit cards typically have higher annual percentage rates (APR) compared to other consumer loans.
  • Interest is charged on unpaid balances, usually starting approximately one month after a purchase.
  • Credit card issuers must offer a grace period of at least 21 days before interest on purchases accrues.

6. Building Credit History:

  • Responsible use of regular and secured credit cards helps build a positive credit history.
  • Making on-time payments, avoiding late payments, and maintaining a low debt-to-income ratio contribute to a good credit score.
  • Becoming an authorized user on an established credit account or opening a secured credit card can help build credit.

7. Credit Card Annual Fees:

  • Credit cards may have annual fees charged by the issuer for extending credit.
  • Some cards, especially those offering rewards, may have annual fees ranging from $50 to $700.

Understanding these concepts is crucial for making informed decisions about credit card usage and managing personal finances effectively. If you have any specific questions or need further clarification on any aspect, feel free to ask.

Credit Card: What It Is, How It Works, and How to Get One (2024)

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