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What are credit cards?

In a credit card, the cardholder charges purchases to the card issuer and then pays them off later, along with other charges such as interest. The cardholder can charge the card up to a specified credit limit continuously, and as soon as they pay back the balance, the funds become available again.

How does a credit card work?

The purpose of credit cards is to let you make purchases up to a predetermined limit at any time on credit. With the understanding that you will pay the credit card issuer back in accordance with the terms and conditions of your card, each purchase is charged by the issuer.

Once every 28 to 31 days, a statement will be issued to summarize your credit card transactions and outstanding balance. This payment cycle concludes with a required minimum monthly payment of either 2% to 3% of your balance or $25, whichever is higher. It is crucial to make this payment on time as it can impact your credit score negatively if missed. Although it is not compulsory to pay off the entire balance at once, it is advisable as any remaining amount will accumulate interest according to your credit card's APR in the following cycle.

Credit card issuers typically approve credit cards based on your credit report, which is pulled when you apply; however, some credit cards consider other factors.

Credit cards: pros and cons

Pros

You can spread the cost of your purchase over time

Convenient

You will not be charged interest if you pay off your balance in full

Fraud prevention

Benefit from rewards and other benefits

The process of building credit

The negatives

There is a high rate of interest

Late payment fees

It is easy to accumulate debt and overspend

It is possible to affect credit scores

Credit cards offer a multitude of benefits for managing payments conveniently. They allow for gradual payment, which is particularly useful for financing significant purchases or handling unforeseen circumstances. Moreover, credit cards provide superior fraud protection with zero-liability policies. This means that if you report any fraudulent charges, you will not bear any responsibility. Additionally, these cards can be advantageous for daily expenses. Responsible and regular usage can aid in building a credit history, and some may even feature rewards that grow parallel to your spending. As long as the full amount is paid off monthly, interest fees will never apply.

This temptation, however, can easily lead to overspending. This is why most credit cards come with relatively high interest rates, which can make it hard to repay debt if you rack up a large balance. Credit cards are notorious for putting people in debt that cannot be managed. High balances and missed payments can ruin your credit as well as costing cardholders a lot of money in fees.

Types of credit cards

There's no such thing as a one-size-fits-all credit card, and they come with a variety of features. If you know what you're looking for and understand different types of credit cards, you'll be able to select the right one. There are some credit cards that charge an annual membership fee (typically the ones that offer more generous rewards and benefits), while others don't.

The best travel credit cards offer additional travel-related benefits, such as airline tickets or hotel accommodations, when you spend money on travel. As well as trip insurance, airport lounge access, travel statement credits, and more, the best travel credit cards offer additional travel-related benefits.

When you use a cash back credit card, you'll earn cash back as a percentage of the purchase price. Some cards offer a flat rate, while others offer bonus cash back.

Two types of low-interest credit cards are available: low-interest credit cards, which offer a relatively low ongoing APR, and 0% intro APR cards, which offer 0% introductory APRs on new purchases, or sometimes new purchases and balance transfers. During the introductory period, the higher standard rate takes effect after 12 to 20 billing cycles.

There is an introductory APR of 0% on balance transfers for an introductory period of up to 21 months on balance transfer credit cards. With a balance transfer credit card, you can avoid interest fees and pay down debt faster if you pay off your balance before the introductory period ends.

When you use a business credit card for business-related expenses, your activity may appear on your business credit report rather than your personal credit report. Because they often come with relevant features like employee credit cards and bonus rewards for business purchases, it's a great way for small business owners to separate their personal and business finances.

A variety of credit cards are available for people with bad or no credit. They include secured credit cards, which require a security deposit as a credit limit. It is a good idea to start building credit from scratch with a student credit card if you have no credit or a thin credit file.

What is the difference between a credit card and a debit card?

Credit cards and debit cards are both card payment methods -- the main difference lies in the way your purchases are funded. You pay for the purchase with your credit card issuer, and then you repay it. The funds from your debit card are derived from your linked checking account, so you can only spend the money in your bank account.

There are also some differences in features. Debit cards do not come with rewards systems or extensive benefits like many credit cards. Your debit activity does not appear on your credit report or affect your credit score. Moreover, debit cards offer less fraud protection than credit cards. When a transaction is fraudulently made with a debit card, you may be held liable for up to $500, while most credit cards have no liability policy.

Credit card terminology

These terms should be understood before applying for or using a credit card.

Lenders and credit card companies use your credit score to determine whether you will be able to repay your debts.

If you attempt to charge more than your credit limit on your credit card, either the transaction will not process or you will be charged an overlimit fee.

After subtracting your current balance from your available credit, you know how much credit you have left on your card.

In other words, it is simply the interest rate on your credit card that determines the cost of carrying a balance.

In most cases, credit cards that charge an annual fee do so because they offer additional rewards and benefits.

You may add an authorized user to your credit card so that they may make purchases on your account. Any activity on this account will affect their credit score.

Credit card billing cycles are determined by the time between the closing date of your monthly statement and the closing date of your next statement.

The statement balance on a credit card statement is the amount owed at the end of the most recent billing cycle.

This number reflects all unpaid charges, including those after your most recent billing cycle ended, on your credit card statement.

A minimum payment due is also displayed on your credit card statement. If you fail to pay this amount, you will likely be charged a late fee, which can negatively impact your credit score.

It must be at least 21 days between the end of your billing cycle and the end of your payment due date if your credit card company offers one. In addition to balance transfers and cash advances, new purchases are not included in this grace period.

In a cash advance, you withdraw cash from an ATM or bank using your credit card. These transactions do not have a grace period, and the APR and cash advance fees are high.

Balance transfers allow you to transfer existing debt between accounts. When you transfer a balance from a credit card with a high APR to one with a low or 0% intro APR on balance transfers, this is typically done in order to secure a lower interest rate or more favorable terms.

Secured credit cards require a security deposit to mitigate the risk of lending to someone with bad credit. The security deposit is the card's credit limit.

History of credit

The concept of credit, in one form or another, has been around for thousands of years, but it wasn't until the 20th century that modern consumer credit became widely available. Many Americans had access to revolving credit accounts with specific stores in the 1950s, but Bank of America launched the BankAmericard (now Visa) in 1958, the first general-purpose credit card. Several years later, American Express and MasterCard were launched.

Credit reporting and scoring evolved during the second half of the 20th century, making them widely accessible. Despite the fact that many populations remain excluded from the credit industry today -- including young adults, immigrants, and formerly incarcerated individuals -- new credit scoring models and products are expanding access to credit.

When applying for a credit card, why are you asked about your income?

Depending on your income, a credit card issuer may approve you for a $1,000, $5,000, or more credit card if your application is approved.

By law, credit card companies must ask applicants about their income. Additionally, they must only approve applications if they are confident that the applicant can afford the monthly payments. However, there are no specific guidelines regarding the amount of credit they can extend.

Besides determining your credit limit, income can also determine if you're approved for a credit card. It is easiest to explain with an example. Certain types of credit cards have a minimum credit limit required. This limit is usually set by the payment network of the card, such as Visa or Mastercard.

There is a minimum credit limit on each of the three most common Visa cards:

Visa® Basic does not have a minimum requirement

For $5,000, a Visa® Signature is required.

Visa® Infinite $10,000

If you applied for a Visa® Signature card with a credit limit under $5,000, the credit card company would deny your application.

It is possible to get approved for a lower limit, but most credit card companies follow the official guidelines.

The setting of credit card limits by credit card companies

When determining your credit limit, credit card companies consider not only your income, but also:

Any monthly debt payments you have

Mortgage or rent

Scores on credit

Other credit cards that offer credit

Any income you have a "reasonable expectation of being able to access" can be included if you are at least 21 years old.

Earnings from your job

Income from freelancing or other independent work

Your spouse's or partner's income

Social Security payments

Retirement fund distributions

Trust fund distributions

Scholarships and grants

If you are under 21, you can only include personal income, allowances, scholarships, and grants.

Is it possible for a credit card company to verify your income?

Most credit card companies will take your word for it and verify your income using your reported income.

What happens if you exaggerate your income since there is no income verification?

However, it is considered loan application fraud, and if you are unable to pay, it may come back to bite you.

The court may not allow you to discharge your credit card debt in bankruptcy if your income on your credit card application is much higher than your actual income. The crime can result in a fine of up to $1 million and a prison sentence of up to 30 years. In some cases, offenders have even received hefty fines and/or imprisonment for the crime.

This information must be included on every credit card application

You need to provide your income when applying for a credit card, but it shouldn't be excessive. You don't have to be a big earner to get a credit card, since most cards are available to people at every salary range. It is just the credit card company's job to make sure you have the right credit limit.

See what issuers offer regardless of your credit history with these credit cards.

How does a credit card work?

Credit cards can be used only if you open a credit account with a financial institution. You are borrowing money from the credit card issuer when using a credit card. The card can be used to purchase goods or services at any merchant that accepts it. Some cards allow you to get a cash advance, but this isn't recommended due to the high fees.

If you spend $100 on a credit card, the balance on the card will increase by $100.

The maximum amount you can owe the bank at one time is determined by your credit limit. For example, if your credit limit is $1,000, then your balance cannot exceed that amount.

Available credit is the difference between your credit limit and your balance. For example, if your credit limit is $1,000 and your balance is $100, your available credit is $900.

A credit card is considered a revolving line of credit if you pay your bill and have available credit.

Annual Percentage Rate is referred to as APR.

Any outstanding balance after the due date is subject to an annual percentage rate, or APR.

Whenever you pay off your card's full statement balance, you won't be charged interest.

An example of how APR works is as follows:

Your credit card has an APR of 20%.

Your account balance is $1,000.

If you don't incur any fees, the balance will grow to $1,200 after one year (20% of $1,000 = $200).

If you pay off the $1,000 balance by the due date, you will not be charged interest.

If you want to avoid fees and keep your account in good standing, you must pay the minimum payments every month. This is just an example to demonstrate how interest works on credit cards.

Building credit

When you've been approved for a credit card, you need to use it in a way that will improve your credit score.

Pay your bills on time

The most important factor in determining your credit score is how well you pay your bills on time.

It is possible to set up an autopay feature with most credit card companies. This ensures that you won't miss a payment.

Monitor your FICO® score

One of the most common types of credit scores used by lenders is the FICO® Score. In order to keep your credit score high, you should check it at least once every few months. Some credit cards come with a FICO® Score tracker, but if you don't have one, you can check it for free.

Keep your balance low

If your credit card balance is too high, your credit score will suffer. To avoid a drop in your credit score, keep it below 30% of your credit card's limit. For example, if your credit card has a $1,000 limit, try to keep your balance below $300.

Your credit limit should be increased

A higher credit limit will help you keep your balances below 30% if you have been using your card and making on-time payments for nine to twelve months.

Keep your account open

Keeping older accounts open can boost your credit score. Your oldest credit card, in particular, should not be closed since it is your oldest.

Make sure you don't apply for new cards too often

When credit is built, more benefits become available to you. There's nothing wrong with opening a new card that could save you money, but don't go overboard.

To improve your credit score, you should only apply for a new credit card once a year or once every six months at most.

What should I look for when choosing my first credit card?

The best first credit card for beginners should have the following features.

Annual fees are not charged

Keeping your first credit card open forever will help extend the age of your credit history. We recommend a card without an annual fee as a first credit card.

Get a free FICO® Score

Some credit cards allow you to track your FICO® Score online.

There is no security deposit required or it is low

Since the credit card issuer receives a deposit upfront, they can be more flexible about who they approve for a credit card.

It is best to choose a secured card with an affordable deposit. It is ideal for cards that offer a $200 credit limit in exchange for a $200 or less deposit.

SEE THE BEST SECURED CREDIT CARDS

Rewards

A beginner credit card is primarily used to build a credit score and qualify for better terms on loans and cards in the future, so rewards aren't really a big deal.

Check out The Ascent's take on credit cards.

If you are applying for your first credit card, you may find the following resources helpful:

How to get your first credit card

These are some things that first-time credit card users should know

Do I need a credit card?

Even if you don't need a credit card, there are several reasons to get one:

When you don't have a credit card, building credit is much more difficult. If you ever want to borrow money, you'll have a hard time getting approved. Furthermore, it can cause you to be rejected from renting a home, and in some states, it may cause you to pay higher car insurance rates.

When it comes to security, credit cards are the best payment method. If a thief uses your credit card fraudulently, you can contact your credit card issuer to have the fraudulent charges removed and to receive a new card. There is a maximum liability of $50 for fraud on credit cards, and many issuers offer zero-liability policies so you will not be held responsible.

You can earn value back on your purchases using credit cards that offer cash back, travel points, or some other reward.

Credit cards vs. debit cards

Taking a closer look at their similarities and differences will help you distinguish between credit cards and debit cards.

Similarities

Both credit cards and debit cards can be used to purchase goods and services. They are both physical cards that are linked to a financial account. The way you use them for transactions is also the same. For physical payments, you insert the card, swipe it, or use contactless payment. For online payments, you enter your credit card information.

Differences

Although debit and credit cards are linked to financial accounts, the accounts they are linked to are different. A credit card is linked to a revolving line of credit.

When you use a credit card, the issuer pays, and you repay them later. When you use a debit card, you pay from your bank account. In the event of a fraudulent charge on your credit card, you can call the bank and ask that it be withdrawn and you won't be out of money. In order to reimburse your account, the bank must investigate if you have been a victim of debit card fraud.

Unlike debit card fraud, credit card fraud doesn't leave your bank account, so it's easier to handle.