Credit cards are a financial tool that gives you a line of credit — or a credit limit — that allows you to spend up to a certain amount. What you spend on a credit card must be repaid, usually with interest.
How do credit cards work?
- Written by
-
Why you can trust us
The team at WealthRocket only recommends products and services that we would use ourselves and that we believe will provide value to our readers. However, we advocate for you to continue to do your own research and make educated decisions.
Credit cards often get a bad rap, but when used correctly, they can be an excellent way to earn rewards, build credit, and improve your financial situation.
This WealthRocket article covers the basics of using a credit card, how credit cards work, their pros and cons, as well as some helpful terms to help you maneuver their usage while staying out of rotating debt.
How does credit cards interest work?
One of the most important things to keep in mind when using a credit card is that the credit card company charges interest on what you owe if you don’t pay off your balance in full each month.
Carrying a balance from month to month, also known as a revolving balance, means you will pay interest not only on what you owe but also on any new transactions that you make.
In other words, your interest is compounding, and that can add up quickly.
Additionally, the average Annual Percentage Rate (APR) on a credit card or APR is around 16%. That’s why you should make a conscious effort to pay off your balance in full each month.
However, using a credit card responsibly is rewarded when paying your balance in full each billing cycle, which can improve your credit score.
It’s worth noting that many credit card issuers offer introductory offers of 0% APR for new cardholders.
This is a great perk, especially if you’re carrying a credit card balance and are considering transferring a balance from another credit card. Typically, those offers are only valid for one year to 18 months from the time you open the card.
However, the interest rate will likely dramatically increase. That means you’ll still need to commit to paying off that balance before then.
Credit cards vs. debit cards
A credit card allows you to borrow money for purchases and expenses.
Anyone with a credit card can swipe or insert your card to make point-of-sale transactions, similar to how a debit card works.
Since credit cards are essentially a line of credit, anything you spend on a credit card must be repaid, with interest.
Credit cards require you to make a minimum payment each month to pay off what you spent. However, it’s best to pay off your balance in full each month to avoid paying more in interest.
Debit cards are also an easy way to make transactions by swiping or inserting your card. They’re also the best method for getting physical cash.
However, debit cards draw the money directly from your checking account. That means you won’t get a monthly statement, won’t pay any interest, and will not build credit.
How to use a credit card
Using a credit card is similar to the way that you would use a debit card. You can swipe or tap your card to pay for purchases or even bills (depending on your credit card provider).
You can also use your credit card to pay for online purchases. You’ll need to input information such as your card number, expiration date, and CVV security code.
Any purchases made on your credit card go towards your credit card balance, which you’ll (ideally) pay in full at the end of each billing cycle.
If you don’t pay off your bill in full each month and instead only pay the minimum payment, interest will accumulate to your statement
Using a credit card responsibly is a great way to build or improve your credit, as long as you pay off your balance each month and keep your credit utilization rate relatively low.
How to get a credit card
To get a credit card, you’ll need to fill out an application and meet some minimum requirements before you can get one.
For example, you’ll need to be at least 18 years old, and have a Social Security number, income, and credit history.
If you don’t meet the requirements, you may be approved for a secured credit card, need a co-signer, or require an authorized user to a parent or guardian’s credit card.
Some cards have additional requirements, such as good credit history, length of credit history, or a certain credit score.
You can check your credit history with one of the three major credit bureaus.
When deciding what card to open, it’s wise to compare the cards’ interest rates (APR), annual fees, and any perks offered by rewards cards.
Tangerine World Mastercard
Rewards
- 2% Earn 2% cash back in up to three spending categories, when you deposit your rewards to a Tangerine savings account.
- 0.5% Earn 0.5% cash back on all other purchases.
- Welcome Offer 10% cash back on up to $1000 Terms and conditions apply
- Annual Fee $0 Learn how we calculate this.
- Annual Rewards $282
- Minimum Income Required $60,000 personal; $100,000 household
-
Pros
- No annual fee
- Unlimited cash back
- Travel perks
Cons
- High qualifying income requirements
- Short period for a lower-interest balance transfer
- No annual fee
The Tangerine World Mastercard is a no-annual-fee cash back credit card designed for the everyday spender who also likes to travel. This card boasts impressive travel perks, such as airport lounge access and Mastercard Travel Rewards, making it an enhanced version of its counterpart, the Tangerine Money-Back credit card. That said, it does have higher qualifying requirements.
Pros & cons of credit cards
Credit cards, while useful, are not entirely flawless or right for everyone. We’ll take a look at some of the pros and cons of using a credit card below.
Pros
It’s an easy way to pay for everyday purchases, travel, and even bills.
If you have a rewards credit card, you can also earn points for certain purchases. Sometimes, the rewards are airline miles on purchases, which can go towards travel.
Using a credit card and paying the balance in full each month is also an excellent way to build or improve your credit. Paying your bill on time each month is also important to build your credit by using a credit card, so be sure to keep your due date top of mind.Keeping your credit utilization low (i.e., how much you spend each month of your credit limit) is another way to improve your credit by using a credit card
Cons
It’s very easy to spend more than you can afford to pay off each month on your credit card, compared to a debit card, because the latter will usually only allow you to spend what you have readily available in your bank account.
Overspending on a credit card can lead to carrying a balance month to month, which means paying more in interest, or, worst-case scenario, spending more than you can pay back. For example, data shows that the average household in the U.S. has nearly $9,000 in credit card debt.
Acquiring too much credit debt can lead to less-than-ideal financial decisions, like debt consolidation or even bankruptcy.
Common credit card terms
If you’re using a credit card, getting the lingo down increases your chances of using one properly and effectively. Get yourself familiar with the following credit card terms.
Annual Percentage Rate (APR)
An annual percentage rate, or the interest rate, is the rate of interest paid on unpaid purchases at the end of the month.
Annual fee
Some credit card companies charge cardholders an annual fee, which pays for their benefits and other features. The average annual credit card fee is $110, though it can be lower or higher.
Balance
A credit card balance is a total amount that you owe on your credit card.
Statement Balance
A statement balance shows you how much you owe the credit card company at the end of a billing cycle. In other words, your statement balance is the total amount of your credit card bill.
Billing Cycle
A billing cycle is a time between your last credit card statement and the one that follows. The average billing cycle is at least 21 days.
Credit Limit
A credit limit is a maximum amount you can charge to your credit card.
Minimum Payment
A minimum credit card payment is the lowest possible payment you can make each month on your credit card.
While it can be tempting to pay only the minimum payment each month, it typically only covers the interest on your balance.
Credit Utilization Rate (CUR)
A credit utilization rate (CUR) is the balance you currently carry on your credit card, versus the amount of your total credit card limit.
Grace Period
A grace period is a time between when your statement ends and when your bill is due.
Zack Fenech
Frequently asked questions
Immediately call your credit card company and alert them of your lost card. They will cancel your current card and issue you a new one. Then keep an eye on your statement for fraudulent purchases.
Not necessarily. However, if you don’t use your card for a certain period, your credit card company may close your account, which can affect your score.
You can build credit by paying your bills on time, keeping your debt-to-income ratio low, or even by being added as an authorized user to a parent or guardian’s account. However, responsibly using a credit card and paying off the balance each month is usually the easiest way to build credit.
