Categorized | Credit Cards

How Do Credit Cards Work

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Credit cards are extremely useful in many situations. They might come with a long list of misconceptions, but having a major credit card to your name is a good thing. For example, did you know you cannot rent a car in many situations without a major credit card? Did you know that even if you can rent a car without a credit card, you must provide either two up-to-date utility bills or household bills of some sort without a late charge or delinquent payment notated, two forms of identification, and even proof of a round-trip airline ticket if you are renting in an airport? Even if you have a debit card or cash, you are often prohibited from renting certain types of cars. Did you know you might not be able to buy a car or a home without a credit card? You need credit to build credit, and that’s why you need a credit card. If you’re asking yourself 'how do credit cards work?' you are not alone.

So, how do credit cards work? The answer is simple, but the details can be tedious. If you’re considering applying for your first credit card, it’s time for you to know how they work, what they do, and how to use one correctly. Otherwise, those misconceptions you have about credit card debt might become your reality.

How Do Credit Cards Work?

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How do credit cards work? That is not an uncommon question at all. Unless you have had them for a while, you certainly have questions and maybe even concerns about these cards. To put it simply, a credit card is a card with a credit line attached to it. The amount of money a credit card company offers you depends on how much you earn, what you owe to other creditors, your credit history, and other factors. If you have little to no credit history, you might not have a large credit limit. For example, someone without a credit history might be offered a credit line of up to $300.


This means you can use your card anywhere you want to make purchases, but only up to $300 in total.


Someone with a great credit history and a big income might earn a much higher credit limit, such as $50,000 on one card. It can be more, it can be less, or it can be a custom amount you ask for when you call the card company and request an increase or a decrease. It all depends on your credit profile.


Once you know your credit limit, you get to use the card at your will. You spend what you want, and then you make a payment at the end of the month. The amount you owe depends on your card, your interest, and your outstanding balance. However, you should always pay more than that amount even though it isn't required.

How to Use a Credit Card

The Inner Workings of a Credit Card

Credit Card Vocabulary

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If you’re asking yourself, “How do credit cards work,” you should update your credit card vocabulary. It makes understanding the terms and conditions simple.


Annual Fee


This is the amount of money a card charges you annually. Some lenders charge you every year to use their card, and the fee varies. Some cards charge as much as $450 while others charge less than $100 annually.


Annual Percentage Rate


This is a term that describes the amount of interest you pay annually. Every purchase you make accrues interest if it’s not paid off in full by the end of the billing cycle. This is the amount you will accrue each month if you don’t make a full payment.


Available Credit


This is the amount of money you have to spend. For example, if you have a $500 credit line on your first credit card, you have $500 available credit. If you spend $50, you have $450 available credit. Your statement will reflect this information.


Cash Advance


This is the money you take from the card using an ATM, and it’s not the same as a purchase. It’s considered a loan from the card, and it’s a loan that comes with a much higher interest rate. It might even come with a fee.


Grace Period


How do credit cards work in terms of grace periods? A grace period is the term used to describe the amount of time you get to make a purchase without paying interest on it. For example, most purchases have a grace period of 20 to 25 days. If you pay the balance on your card before that grace period, you do not pay interest.


Minimum Payment Due


This is the amount of money you must pay to ensure your account is current and you meet all requirements. If you’re not using a full payment to keep the balance paid off, you will pay this amount. If you pay less than this amount, you will incur late fees and other penalties.


Secured Card


A secured card is typically one that you get if you have bad or no credit. You pay a deposit, and that deposit is the amount of your credit limit. Once you use the card for a year or more without any issues, you will receive your security deposit back and call the card an unsecured card, which doesn’t require a deposit.


Late Fee


This is the fee you pay if your payment is late. Unlike a car payment or a mortgage loan, you don’t have a 10 to 15 day grace period to make your payment without a late fee. If your payment is due Monday before midnight and you pay the bill on Tuesday at 12:01 am, it’s late and you owe a late fee.


Balance Transfer


This is a balance you take from one card and transfer to another card. This is usually done when you don’t want to pay a high-interest rate on a debt you have, and you have a new car with a zero percent interest rate for a certain amount of time. You pay a fee to transfer a balance.


Foreign Transaction Fees


This is a fee you incur if you use your card in another country. Whether it’s an ATM in the Bahamas or Africa, it’s foreign and you pay an expensive fee each time you use the card. If you can, find a card with no foreign transaction fees.


Debit Card


This is not a credit card. This is a bank-issued card, and it is tied to your checking account. This means you must have money in the bank to use this card. If you do not have the funds to use the card, you cannot make the purchase. This is not as secure as a credit card.


Charge Card


This is not the same as a credit card. A charge card is similar to a credit card in that you can make the purchase now and not pay for it right away. However, you do have the pay the balance of your card every month. It’s not a card you can use to carry balances over into the next month.

Interest Rates and Fees

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The concept of interest rates and fees can be quite confusing when you ask yourself, "How do credit cards work?"

How Do Interest Rates Work?

What Fees Are Assessed?

Conclusion

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Are you still asking yourself the question of 'how do credit cards work?' They work according to the terms and conditions given to you when you apply for the card. If you want a good rate and a great card, you must have an excellent credit history. Think about what you’re willing to risk by signing up for a card, and then decide if it’s right for you.


Read the fine print prior to making a decision. 


Now that you’re familiar with the terms used in credit card statements, this should be fairly simple. Making an educated decision can save you from incurring too much debt. Never fret when wondering about how do credit cards work. There is plenty of information and resources available that can help you make the best decision for you and your lifestyle.

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