The Complete Guide on How Do Credit Cards Work and Manage

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Posted Dec 18, 2024

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Credit cards are a convenient way to make purchases, but they can be confusing if you don't understand how they work.

You're approved for a credit card when a lender decides you're a low risk for defaulting on payments. This is based on your credit score, income, and other factors.

The credit limit is the maximum amount you can charge on your card, and it's determined by the lender. It's essential to only spend up to this limit to avoid high interest charges and fees.

How Credit Cards Work

A credit card allows you to use a line of credit to borrow money to make purchases.

Your available credit is reduced by the purchase amount each time you make a purchase.

That amount is owed to your credit card issuer, which is based on factors like your creditworthiness and determined by things like your payment history.

Any amount that isn't paid back by the due date could be subject to interest charges.

The amount you can borrow is known as your credit limit, which is based on factors like your creditworthiness.

Funds can be borrowed and paid back repeatedly, up to the credit limit, making it a form of revolving credit.

Payments

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Credit card payments are a crucial part of using a credit card responsibly. Payments are usually due on the same day each month, but if the due date is on a holiday or weekend, the payment may be due the following business day.

To avoid late fees, make sure to pay your credit card payment on or before the due date. This is one way to keep your account in good standing.

A minimum payment is the least amount of money you have to pay each month to keep your credit card account in good standing. This is a key concept to understand when managing your credit card payments.

Here are some key terms to know on your credit card statement:

  • Minimum payment: A minimum payment refers to the least amount of money you have to pay each month to keep your credit card account in good standing.
  • Available credit: Your available credit is the amount of credit you have left to spend on your credit account.
  • Statement balance: A statement balance is what you owe at the end of a billing cycle, which is usually every 28-31 days.
  • Current balance: This is the most up-to-date amount owed on the credit card, and it grows as you make purchases.

Keep in mind that paying your statement balance in full each month can help you avoid interest on new purchases during that time.

Fees

Credit card fees can be confusing, but they're an important part of understanding how credit cards work.

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Some credit cards come with an annual fee, which is a kind of membership fee you're charged once a year to offset some of the benefits the card offers. This fee can range from $50 to $700, depending on the card.

If you're late with your credit card payment, you may be charged a late fee. Missing two or more payments could result in higher fees and a higher penalty APR.

A credit card balance transfer allows you to move credit card debt to a different card from another issuer, but you might be charged a fee for completing a balance transfer.

You can use your credit card to withdraw cash against the card's line of credit, but this is called a cash advance and may come with additional fees.

Here are some common credit card fees you might see on your statement:

  • Annual fee: $50 to $700
  • Late fee: varies
  • Balance transfer fee: varies
  • Cash advance fee: varies

Debit cards, on the other hand, don't usually charge annual fees, but they may carry overdraft fees if there are insufficient funds in the associated checking account.

Credit Score and History

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Using a credit card responsibly can have a significant impact on your credit score and history. You can positively affect your credit score by making on-time payments each month, keeping your debt under control, and maintaining a good credit age. Your credit age indicates how long you've had your credit accounts open, and a longer positive credit history can have a positive impact on your credit scores.

Credit-scoring companies like FICO and VantageScore take a number of factors into account when calculating credit scores. These factors include payment history, debt, credit age, credit mix, and new credit.

Here are the key factors that affect your credit score:

  • Payment history: Make on-time payments each month.
  • Debt: Keep your debt under control and maintain a good credit utilization ratio.
  • Credit age: A longer positive credit history can have a positive impact on your credit scores.
  • Credit mix: Using different types of credit responsibly can positively impact your credit scores.
  • New credit: Avoid applying for too much credit in a short period of time.

Regularly monitoring your credit can help you understand how these factors affect your credit. You can get free copies of your credit reports from all the credit bureaus by visiting AnnualCreditReport.com.

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.

Credit Card Types and Features

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Most major credit cards are issued by banks, credit unions, or other financial institutions, and they often come with rewards like airline miles or cash back on purchases.

Many national retailers issue branded credit cards with the store's name on them, making it easier to qualify for one, but they can only be used at the issuing retailer.

Secured credit cards require a deposit to get and use the card, and the available credit is equal to the deposit, which can be refunded after responsible card usage.

Unsecured credit cards don't require deposits or collateral, offering higher lines of credit and lower interest rates than secured cards.

Fees are a major part of credit cards, and some no-annual fee credit cards are available, but they often don't offer many perks or rewards.

Types of

Most major credit cards are issued by banks, credit unions, or other financial institutions. These cards are often referred to as rewards credit cards, which offer incentives like airline miles, hotel room rentals, and cash back on purchases.

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Store credit cards are issued by national retailers and can be used only to make purchases from the issuing retailers. They may offer perks like special discounts, promotional notices, or special sales.

Secured credit cards require a deposit to get and use the card, with a limited line of credit equal to the security deposit. This type of card is often chosen by people with limited or poor credit histories.

Prepaid debit cards are similar to secured credit cards, with available funds matching the money deposited in a linked bank account. Unsecured credit cards, on the other hand, don't require security deposits or collateral and offer higher lines of credit and lower interest rates.

No-annual fee credit cards are an option for those who don't want to pay a yearly fee to access and use the card. These cards typically don't offer a ton of perks and rewards, but can be a good choice for someone who wants a simple credit card.

Fixed or Variable APRs?

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Credit cards can have either fixed or variable annual percentage rates (APRs), or even both. Card issuers are required to disclose the type of APR in the cardholder agreement.

If you have a fixed APR, it's locked in and won't change unless the card issuer alerts you first. This means you can budget with confidence knowing your interest rate won't surprise you.

Some credit cards have different APRs for different types of transactions, like cash advances or late payments. These variable APRs can be higher than the fixed APR for purchases.

Reading the fine print is crucial to understanding your APR, as it can be hidden in the cardholder agreement.

Debit

Debit cards are tied to a checking account, so the money you can spend is limited to what you have in that account. This means you can only spend what's available in your account, and you won't be able to borrow money or build credit with a debit card.

Credit card rewards are much more abundant and lucrative than debit card rewards, and credit cards have better fraud protections. This is a key difference between the two types of cards.

Getting and Managing a Credit Card

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To get a credit card, you must first apply, and the bank or credit union issuing the card will evaluate your credit history, income, debts, and other factors to determine whether you're an eligible borrower. You can apply online, by phone, or in-person with many cards.

Applying online can result in instant approval, but it can take up to 14 business days to get a decision. After being approved, it generally takes 7-10 business days to receive the card in the mail.

If you're new to credit, opening a secured credit card is a simple way to get started. This type of card requires a deposit, which reduces the risk for the lender and gives them a snapshot of your spending and repayment habits.

Becoming an authorized user on an established credit account, such as a parent or spouse, is another way to start building credit. However, be aware that if the cardholder has poor credit habits, it will also negatively affect your credit.

Making credit card payments on time is essential to lower your credit-debt ratio and improve your credit score. At the very least, make the minimum monthly payment on or before the due date to avoid late fees and negative credit reporting.

Frequently Asked Questions

What's the minimum payment on a $500 credit card?

The minimum payment on a $500 credit card is typically 1-3% of the outstanding balance, so in this case it would be $5-$15. However, the exact amount may vary depending on your credit card issuer's specific calculation method.

How do payments on a credit card work?

When you use a credit card, you're borrowing money from your provider to make a purchase, and you have the option to pay it back in full or over time. This flexible payment structure is a key feature of credit card borrowing.

How does a $1000 credit card work?

A $1000 credit card allows you to make purchases up to $1000, with the option to spend less or pay off the balance in full. Your available credit will be reduced by the amount you spend, but you won't have to pay it all at once.

What is the minimum payment on a $3,000 credit card?

The minimum payment on a $3,000 credit card balance is $30, plus any applicable fees, interest, and past-due amounts. This amount may be higher if you've incurred late fees or missed a previous payment.

Jackie Purdy

Jackie Purdy

Junior Writer

Jackie Purdy is a seasoned writer with a passion for making complex financial concepts accessible to all. With a keen eye for detail and a knack for storytelling, she has established herself as a trusted voice in the world of personal finance. Her writing portfolio boasts a diverse range of topics, including tax terms, debt management, and tax deductions for business owners.

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