Understand Your Credit Card

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7 minutes read

Last updated: 06/29/2020
Understand Your Credit Card

How Credit Cards Work

You apply for a credit card by filling out an application form that discloses information about your finances and employment. The card issuer will check your credit score and history with one or more credit bureaus. When you receive a credit card, you’ll notice it’s branded with a card network, such as American Express, Discover, MasterCard or Visa. The card network decides where you can use the credit card and facilitates payments to the merchants you pay with the card. 

The merchant might be a brick-and-mortar provider of goods or services, at which you present the card at the checkout register where it’s electronically read. Your card balance is immediately updated by the payment amount. To make online purchases, you provide the credit card number, the card expiration date and a 3- or 4-digit PIN. The merchant’s bank (the acquiring bank) routes the payment transaction to the cardholder’s bank (the issuing bank) to get paid. The two banks participate in a settlement process that ensures payments are properly deposited into the merchant’s account.

Every month, you receive a paper or electronic bill that lists all your transactions, any interest charges and fees, your current balance, the minimum payment due and the due date. You can pay any amount from the minimum to the full balance by issuing a check or electronic payment from your checking account. You can also pay with a money order or you can go into the issuing bank and pay with cash. You’ll usually be charged a late fee if you miss a payment or if you remit less than the minimum.

Why Should You Have a Credit Card?

Credit cards are a substitute for cash payments. Having credit cards in your wallet frees you from carrying around a wad of cash to cover your purchases. They also substitute for checks written against your checking account. Cash payments are immediate - you hand over the money in return for your purchase and a receipt. Checks take a few days to clear, but debit card payments immediately reduce your checking account balance. On the other hand, credit cards let you manage the size of your monthly payments. This allows you to buy things even if you don’t have enough cash to pay in full. 

Other reasons to have a credit card include:
  • You can use a credit card to get a cash advance from your bank and to make online purchases
  • You can establish your credit history and credit score. If you already have a credit score, you can use your credit card to improve the score by using your cards responsibly
  • In many situations, your credit card can serve as identificationYou can add other persons, such as a spouse or child, to your credit card account to give them access to your credit
  • Credit cards provide detailed information that helps individuals, businesses and other entities organize their financial data. Card statements and receipts document purchases, which can be important for a variety of reasons, such as taking a tax deduction or providing proof of purchase
  • As we’ll discuss below, credit cards offer a variety of usage rewards

What's APR?

APR stands for annual percentage rate. It represents in a standardized way the interest rate the credit card charges. The APR indicates the interest you’ll pay when you carry a balance beyond the month of a purchase - if you pay the full amount each month, you avoid interest charges. The credit card applies a daily interest rate on your carried balances and sums up your interest for the billing month.

Your next credit card statement will show the interest you owe. APRs vary widely, depending on the creditworthiness of the cardholder and the annual fee charged by the card. Some cards charge no annual fee, whereas others charge up to $500 or more. 

Typical credit card APRs range from 11% to 30%. The average credit card APR in 2018 reached 16.71%, an all-time high. The APR for cash advances is generally higher than for purchases and is charged every day you have a non-zero cash advance balance. 

What's a Credit Limit?

Your credit card comes with a credit limit, which is the maximum balance you can accumulate. Your credit limit depends upon your wealth and income, your monthly bills and your credit score. Folks with poor or no credit can get a secured credit card to establish a credit limit by depositing cash collateral into a special account. If you overspend your limit, your excess credit card transactions might be declined.

What's a Balance Transfer?

You can transfer multiple credit card balances to one card, making it easier to manage your payments. Many cards offer an introductory 0% APR on balance transfers that occur soon after opening the card account, although a one-time fee is usually charged for each transfer. Typically, the introductory period ranges from 6 to 15 months. 

What Types of Perks Do Differnet Cards Offer?

In addition to the 0% introductory offer on cash balances, many cards also offer a 0% introductory period for purchases. Furthermore, most cards offer one of three types of rewards:
  • Cash back: you receive cash rebates based upon the amount you spend
  • Miles: you accumulate frequent flier miles that you can redeem for tickets at one or more airlines
  • Points: you can redeem the points you earn for specified goods and services
Rewards vary by card and sometimes by merchant type. For example, a cash back card might offer one rate for purchases from a quarterly rotating type of merchant and another rate for all other purchases. Many cards offer bonus rewards if you spend a specified amount during the first few months after opening the account.
Finance Guru

Finance Guru