Getting a credit card has its advantages. Credit cards are convenient for making purchases, and some even offer rewards on what you spend. What's more, a credit card can be a helpful tool for building a positive credit history. If you're looking for your first credit card, it's important to understand how they work and how to use them to your advantage.
- Credit cards can be a helpful way to build or rebuild your credit history.
- Unlike debit cards, which are linked to a bank account, credit cards are essentially a way to borrow money in the short-term, which you then repay.
- Understanding how grace periods and interest charges work is important for managing the costs of using credit.
- Your credit score can be influenced—for good or bad—by how you use your credit card.
How Credit Cards Work
A credit card allows you to make purchases and pay for them later. In that sense, it's like a short-term loan.
When you use a credit card to make a purchase, you're essentially using the credit card company's money. You then pay that money back to the credit card company, with or without interest, depending on the timing of your payment.
Your credit card company gives you a credit limit you can make purchases against. This limit will be based on things like your credit score, income, and account history. As you charge purchases to your card, your available credit shrinks. As you make payments against your balance, you free up available credit again.
Each month, you'll receive a statement showing your account activity. This statement includes:
- Your total card balance
- Your available credit limit
- Purchases you made during that billing statement cycle
- Minimum payment due
- Payment due date
The minimum payment due is the smallest amount you have to pay for that month. But it's always a good idea to pay more than the minimum if you can.
Your card statement will also tell you how much it will cost you to pay off the balance over time with interest. You can avoid interest charges on credit card balances by paying your bill in full during the grace period. A credit card grace period is a set time period, typically 20 to 30 days, that you have to pay off recent purchases before interest starts accruing.
If you don't pay in full, interest begins to accrue. The amount of interest you pay is determined by your card's annual percentage rate, or APR. The APR reflects the interest rate for the card, along with any fees the card charges, annualized as a percentage.
Credit cards can have more than one APR. For example, your card may have one APR for purchases, another for balance transfers, and still another for cash advances. Some cards also offer promotional APRs that apply to purchases and/or balance transfers for a limited period of time after you open your card account.
How to Use a Credit Card
Credit cards are easy to use. If you go into a store, for instance, you may be prompted to insert your card in a chip reader or swipe it at the checkout. You can also add your card to digital wallet apps for contactless payments in stores. When shopping online, using your credit card is a matter of entering your card information, including:
- Your card number
- The expiration date
- Your card's CVV security code, which is typically printed on the back
When you use your card to make a purchase, the merchant, the credit card company, and the card network (such as Visa or Mastercard) coordinate to authorize and process the payment. All of this is done electronically and practically instantaneously.
It's also important to use your credit card in ways that will help boost your credit score, while not costing you more than necessary in terms of interest and fees. For example:
1. Pay Your Bill on Time
Credit scores are based on a variety of factors, but your payment history is the most important one. Paying your bills on time can help your credit score, while paying late or missing payments altogether can severely damage it. So the first tip for how to use a credit card is to be sure you make payments on or before the due date every month.
You can schedule automatic payments from your bank account or set up due date reminders through your credit card account to minimize the risk of paying late.
2. Know How Your Card's Interest Is Calculated
Interest charges can make everything you buy with your card more expensive if you carry a balance from month to month. When you open a credit card account, be sure you understand what the APR is and how interest accrues on purchases.
Remember, you can pay off purchases interest-free during the grace period. Also, be aware that if you have balances with different interest rates, your payments may be applied differently. For example, say you have one balance at a promotional 0% APR and another at the regular purchase APR. Anything you pay over the minimum would be applied to the balance with the highest APR first.
Cards with promotional offers may charge 0% interest on purchases and/or balance transfers, but these rates don't last forever. Any remaining balance you owe after the promotional period ends will be subject to the card's regular APR.
3. Watch Out for Credit Card Fees
Credit cards can charge numerous fees, which also add to the cost of using them. Some of the most common fees you may encounter are:
- Annual fees
- Foreign transaction fees
- Balance transfer fees
- Cash advance fees
- Late payment fees
- Returned payment fees
All of these fees, as well as the card's APRs, should be listed in your card agreement. You can also find them online before you apply. If you're considering a card with an annual fee, weigh that against any value the card might offer via a rewards program or other benefits. Many cards are available without annual fees.
Similarly, if you plan to spend time abroad, you might want to opt for a card that doesn't charge foreign transaction fees.
4. Keep an Eye on Your Balance
After your payment history, the second most important factor that affects your credit score is your credit utilization ratio. It measures how much of your available credit you're using at any given time. Generally, it's better to keep your card balance low relative to your credit limit. Maxing out your credit cards can cause your credit score to drop and also send a signal to lenders that you may be a higher risk borrower.
A common credit card myth is that carrying a balance will improve your credit score. On the contrary, carrying a balance can potentially hurt your score if it means you're using more of your available credit. You can help your score—and save money at the same time—by charging no more than you can afford to pay in full each month.
The Bottom Line
Credit cards (even secured credit cards) can help you build credit, but they can also work against you if you use them incorrectly. When comparing cards, be sure you understand what you'll pay in interest and fees, as well as what you stand to gain from any rewards and other card benefits. Once you begin using a credit card, check your free credit reports periodically to make sure your account activity is being reported correctly. That can also be a good way to spot potential fraud or identity theft if your card is ever lost or stolen.