How Do Credit Cards Work?

Credit cards can help you build credit while offering convenience

When you need to make a purchase or pay a bill, credit cards can offer both convenience and the potential to save money if you’re earning back some of what you spend in rewards. At the same time, you can also use credit cards to build credit history through healthy financial habits.

While credit cards and debit cards may look similar, they work very differently. If you’re new to using credit, here are a few important credit card facts to know. 

Key Takeaways

  • Credit cards have a credit limit that you can make purchases against, then repay at a later date.
  • Carrying a balance on a credit card can trigger interest charges. 
  • It’s important to read the fine print closely on credit card promotional offers.
  • Some credit cards allow you to earn rewards on purchases in the form of points, miles, or cash back.

What Is a Credit Card?

A credit card is a physical card that can be used to make purchases, pay bills, or, depending on the card, withdraw cash. The simplest way to think of a credit card is as a type of short-term loan.

When you open a credit card account, your credit card company gives you a set credit limit. This is essentially an amount of money that the credit card company allows you to use to make purchases or pay bills. Your available credit is reduced as you charge things to the card. You then pay back what you spent from your credit limit to the credit card company. 


Credit cards can be secured or unsecured. A secured credit card requires a cash deposit to open, which typically doubles as your credit limit.

How Credit Cards Work

Credit cards can be used to make purchases online or in stores and pay bills. When you use a credit card for either one, your card details are sent to the merchant’s bank. The bank then gets authorization from the credit card network to process the transaction. Your card issuer then has to verify your information and either approve or decline the transaction.

If the transaction is approved, the payment is made to the merchant and your card’s available credit is reduced by the transaction amount. At the end of your billing cycle, your card issuer will send you a statement showing all the transactions for that month, your previous balance and new balance, your minimum payment due, and your due date.

The grace period is the period of time between the date of a purchase on your card and the due date listed on your statement. During this period, if you pay your bill in full by the due date, no interest charges accrue. 

But if you carry a balance month to month, your card issuer can charge you interest. Your credit card’s annual percentage rate (APR) reflects the cost of carrying a balance on an annualized basis. Your APR includes both your interest rate and other costs, such as an annual fee if your card has one.

Most credit cards have a variable APR that’s tied to the prime rate. This means that your card’s APR can change over time, though the Credit Card Accountability, Responsibility, and Disclosure (CARD) Act of 2009 sets strict guidelines on when credit card companies can and can’t raise your rate.


Being 60 days late on making payments to your credit card can trigger a penalty APR, which can approach the 30% range.

Types of Credit Cards

There are several types of credit cards, with the biggest category being rewards cards. Rewards credit cards can include travel-related rewards earned for purchases. You may also earn more rewards for spending in certain categories. Many reward cards are co-branded with certain airlines or hotels.

Similar to rewards cards are cash-back cards, which offer a certain level of cash back (such as 2% or 5%) for spending. Secured credit cards are for those looking to build or rebuild their credit. If your credit profile is thin, you may be able to get a secured card, which requires a security deposit that is held as collateral by the issuer.

Student-focused credit cards also help those with little credit history build credit. These cards are tailored to those in college and may offer little in terms of rewards.

Credit Card Fees 

With credit cards come various fees—not just the interest rate. Other fees can include balance transfer fees, or fees charged for transferring your balance to another card. These fee is usually a percentage of the balance transferred, such as 2%. 

There may also be over-limit fees, which are charged if you go over your card’s limit. Of course there are late fees, which are charged if you don’t make the minimum payment by the due date. Note that if you’re late on a payment, the issuer may also revoke any introductory rate you had.

Credit Cards vs. Debit Cards

A credit card and a debit card may seem like the same thing, but they’re not. When you make purchases with a credit card, you’re not actually spending any of your own money at that moment. Instead, you’re spending the credit card company’s money, which you then have to pay back, potentially with interest.

Debit cards, on the other hand, are linked to your checking account (they’re not exactly the same as a prepaid card). When you make a purchase with your debit card, the money is automatically deducted from your bank account as soon as the transaction is processed. There’s nothing to pay back later, since the money has already been taken from your account.


Many credit card issuers offer a $0 fraud liability guarantee automatically, meaning that you aren’t responsible for any fraudulent charges made with your card.

Debit and credit cards also differ in terms of their credit score impact. Using a debit card has no impact on your credit score because your bank account activity is not reported to the credit bureaus.

Credit cards, on the other hand, can impact your credit score directly. FICO Scores, for instance, calculate your scores based on:

  • Payment history
  • Credit usage
  • Credit age
  • Credit mix
  • Inquiries for new credit

Making credit card payments on time can help your score, while paying late could hurt it. Similarly, keeping a low balance compared to your credit limit can have a positive impact, while maxing out your card limits can detract from your score.

Another key difference between debit cards and credit cards lies in fraud protections. Federal law offers more fraud protections for credit cards than debit cards. This chart highlights your liability for unauthorized transactions with debit and credit cards.

Debit Cards vs. Credit Cards
Debit Card Liability Credit Card Liability
You’re not responsible for unauthorized transactions if a lost or stolen card is reported before it’s used by someone else. If a lost or stolen card is reported within two business days, your liability is limited to $50. If a lost or stolen card is reported more than two business days later, but less than 60 calendar days after your statement is sent to you, your liability is limited to $500. If a lost or stolen card is reported more than 60 calendar days later, you’re responsible for all unauthorized transactions. If your card isn’t lost but is used to make unauthorized transactions, you’re not liable if they’re reported within 60 days of your statement being sent to you. Under the Fair Credit Billing Act, your liability for unauthorized card use is limited to $50. If your credit card number is stolen, but not the card itself, you are not responsible for unauthorized purchases. 

Pros and Cons of Credit Cards

The biggest advantage of using a credit card is the ease of use and safety. If your card is lost or stolen, you will likely be reimbursed for any fraudulent charges. You may also be able to get an 0% introductory rate for a set period (such as 18 months) that will allow you to make a large purchase and pay it off over time without incurring interest charges.

You’ll also get rewards or cash back with most cards, which is a free incentive to use the card. Credit cards can also help boost your credit score if used responsibly.

On the flip side, credit cards can come with high interest rates, which can be expensive if you don’t pay your balance in full monthly. With credit cards, it can also be easier to spend more money than you can reasonably pay off in a short period of time.

If your debt spirals and you can’t make minimum payments on your cards, your credit score will take a hit. You will also rack up late fees and likely be subject to an even higher interest rate.

Credit Card Pros & Cons

  • Ease of use 

  • Safer than cash 

  • Rewards and cash back 

  • Can boost credit score 

  • High interest and fees 

  • Potential debt spiral 

  • Can hurt credit if payments are missed

How to Compare Credit Cards

If you’re in the market for your first credit card or your next credit card, it’s important to do some comparison shopping. Some of the key things to look for when comparing credit cards include:

  • Regular variable APR for purchases
  • APR for balance transfers and cash advances
  • Promotional APR terms and conditions
  • Annual fees
  • Rewards programs
  • Introductory bonus offer terms

It’s also helpful to look at the card’s other benefits and features, if any. For example, if you’re interested in opening a travel credit card to earn miles or points toward flights and hotel stays, you may also be interested in finding a card that comes with benefits such as airport lounge access or airline fee credits. If a card has an annual fee, it’s helpful to compare the value of rewards and benefits to the fee to decide if it’s worth it.

Why You Should Use a Credit Card

Overall, the pros of having and using a credit card outweigh the cons (for most people). They’ll help you build credit—if used responsibly. Good credit helps lower the interest rates you’ll pay for other loans, such as home or car loans. Credit cards can also help with budgeting, either through the budgeting tools that the issuer offers or by allowing you to track and categorize spending. 

And of course, credit cards tend to offer rewards or cash back. If you have a high amount of spending, such as on dining out or flights, you can take advantage of cards that offer high rewards rates in those categories. 

But perhaps one of the biggest reasons to use a credit card (over, say, cash or a debit card) is the fraud protection. If there are fraudulent charges made on your card, or if it’s lost or stolen, you’re protected from fraud liability. 

What are the main differences between credit and debit cards?

You’re essentially borrowing money to make purchases when you use a credit card. Any balance not paid back during the billing month accrues interest that must be paid. Debit cards are linked to a bank account. When you make a purchase with your debit card, the money is automatically deducted from your bank account as soon as the transaction is processed.

How does a credit card help you build better credit?

When used properly, credit cards will help you build credit history through healthy financial habits. When the balances are paid off monthly, you establish a reputation as a good credit risk. This boosts your credit score, which may make you eligible for lower-interest-rate loans and credit cards, and generally improved financial terms, when borrowing.

How does a person shop for credit cards?

Comparison shopping is how you find the best card for you. Compare things like regular variable annual percentage rate (APR) for purchases; APR for balance transfers and cash advances; promotional APR terms and conditions; annual fees; rewards; and more.

The Bottom Line

Credit cards can be a credit-building tool if used responsibly. Paying your bill on time, maintaining a low balance, and only opening credit cards as needed can help you build and maintain good credit. Also, keep in mind that the best way to avoid interest charges and build a strong credit score is by paying your bill in full each month.

Article Sources
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  1. Consumer Financial Protection Bureau. “CARD Act Report.”

  2. Consumer Financial Protection Bureau. “What Is the Difference Between a Prepaid Card, a Credit Card, and a Debit Card?

  3. Consumer Financial Protection Bureau. “Credit Cards.”