How Do Credit Cards Work?

Credit cards are a useful modern tool that many people can find useful. They offer a convenient and flexible payment option and some even offer rewards, points, discounts, and other benefits for their cardholders too.

Understanding how credit cards work is essential to making them work for you. Let’s explore the mechanics of how credit cards work and other basics like interest rates, fees, and rewards so you can know how they work and how to use them to make the most out of this financial tool.  

If you need to pay for a larger purchase in installments, you can also take out a Check City Installment Loan and avoid any hassle with multiple cards.  

What are Credit Cards?‍

A credit card is a type of payment card that allows the cardholder to borrow funds from a line of credit account. It’s a card linked to a type of revolving credit account that offers an amount of credit that cardholders can use, pay off, and reuse so long as they have the credit card account.

Knowing how credit cards work can be really helpful because it can be a great financial tool and can provide benefits like a convenient and flexible form of payment, a widely accepted form of payment, purchase insurance coverage, perks, points, discounts, rewards, and even cash back.

Different Types of Credit Cards

Before we get into how credit cards work, let's discuss the different types of credit cards. There are several different types you might choose from. Basic credit cards may not offer any additional perks besides a convenient payment option, while rewards credit cards can offer cashback, travel points, and discounts.  

Balance transfer credit cards allow cardholders to consolidate debt onto one card and secured credit cards can help people with poor credit build better credit scores.

A student credit card can come with special perks for students who may be just starting their credit history.

Business credit cards are geared toward tracking and managing business expenses for business owners. And store credit cards are designed by businesses for their customers to be used for store purchases only.  

Different Types of Credit Cards:

• Basic Credit Cards
• Rewards Credit Cards
• Cashback Credit Cards
• Travel Credit Cards
• Balance Transfer Credit Cards
• Secured Credit Cards
• Student Credit Cards
• Business Credit Cards
• Store Credit Cards

How Credit Cards Work

Now that we understand what they are let's go over how credit cards work. Credit cards work by providing a line of credit that account holders can access through their card.

A credit card will often come with a credit limit, or a limit to how much you can borrow. Cardholders can then use that credit limit to make purchases and repay what they borrowed to restore the available credit balance again.

That being said, how do credit cards work in general? Let’s explain.  

Step 1: Apply for a Credit Card

If you want to have a credit card you have to submit an application first. A credit card application will look at things like your personal information, financial information, credit history, and more. Applying for a credit card can potentially affect your credit score, so be aware of that before you apply.  

Who Offers Credit Cards?

Credit card issuers include financial institutions like banks and credit unions, but they can also be offered through the brands you love to shop. These retail store credit cards are normally facilitated by a financial institution that the brand has partnered with and are often only useable in the stores that offer them.  

Step 2: If Approved, Get the Card

If you are approved for a credit card, then you’ll get your card. Usually, you’ll get your new card sent to you in the mail. You’ll also be given a credit limit with an available balance you can use.  

Step 3: Activate the Credit Card

Once the card comes in the mail, activate it by following the instructions on the card. Often these instructions are on a sticker on the card and can include visiting an activation webpage or calling a phone number. You'll also set up the card's PIN number now.  

Step 4: Use the Credit Card Responsibly  

Now that you have the card and it’s all set up, you can start using your new credit card to make purchases, earn rewards, and more! Just make sure you use your credit card responsibly.  

How to Use a Credit Card Responsibly:

• Pay your bill on time
• Keep your outstanding balance low
• Pay your balance in full as much as possible
• Plan credit card usage into your budget  
• Review your monthly statements  

Step 5: Keep Up with Credit Card Payments

Keep up with credit card payments by making payments as you use it. Do this by keeping your outstanding credit card balance low and avoid borrowing more than you can pay off each month.  

Making on-time payments has to do with the card’s billing cycle and statement.  

A billing cycle is the timeframe when transactions are recorded to generate a statement. A statement is a summary of a card’s transactions, payments, due dates, balances, fees, interest, and any other relevant information from that statement’s billing cycle.

Billing cycles are usually around 28 to 30 days depending on the card and if you borrowed from the card, then there will be a minimum payment due during this cycle. Avoid defaulting on payments by making at least the minimum payments on these due dates.  

Interest charges will accrue on whatever remains in the account after the billing cycle ends and begins again. Avoid paying interest charges by keeping this amount zeroed out after each billing cycle.

Pros and Cons of Credit Cards

There are many pros and cons of credit cards. Using them can get you cash back and other rewards that can save you money. But they can also get you into lots of debt if you aren't careful and don’t keep your credit utilization rate low.

The pros to credit cards include a convenient and flexible payment option for your purchases. Many cards also offer a type of purchase protection on your purchases in case the card is stolen or the product needs additional purchase insurances. When used wisely, cards can also help build credit.  

However, the cons to credit cards could include accumulating debt, having to pay interest charges, annual fees and other fees, or accidentally overspending more than you should on the card. Mismanaging credit can have a negative impact on your credit score instead of build it.  

How to Pick a Credit Card

The key to picking out a credit card is knowing which one will most benefit you specifically. Maybe you travel a lot and would gain the most rewards from a travel card or maybe don’t travel very much so a cashback card would benefit you more.  

Think about where you shop the most and what shopping categories or spending categories you spend the most money on. You'll get the most benefit from a card that offers good rewards for a spending category you already use a lot.  

How many credit cards should I have? How many credit cards you should have depends entirely on your unique financial situation. Take a close look at your current credit usage and how much its helping or hurting you financially.

If you do really well with credit cards and gain a lot of benefits, this number could be higher, but if you struggle to gain more benefits than charges, or you're already living paycheck to paycheck and can't afford any monthly payments, this number might be lower or even zero.

Prepaid cards are another option if you want a card you put money into instead of a card you borrow from.