How Do Credit Cards Work?

Types of credit cards

• Rewards credit cards

  Rewards credit cards let you earn points, cash back or miles when you use the card to make eligible purchases. Depending on the credit card, you may be able to redeem your rewards for travel, statement credits, checks, direct deposits, gift cards, merchandise or donations.

  Check out our list of the best rewards credit cards.

• 0% APR credit cards

  These cards offer a 0% intro APR on purchases and/or balance transfers with periods ranging from six to 21 months. During the introductory period, you won’t be charged interest if you carry a balance on your card from month to month. However, once the intro period ends, you’ll owe interest at the regular rate if you don’t pay your balance in full each month.

  Check out our lists of the best 0% intro APR cards and the best balance transfer cards.

• Travel credit cards

  Travel credit cards typically offer elevated rewards on travel-related purchases, like airfare and hotel stays. You can use these rewards to help offset the cost of future travel. Depending on the card, you may also get access to valuable travel perks, like free checked bags, annual travel credits, airport lounge access and travel cancellation insurance.

  Check out our list of the best travel credit cards.

• Secured credit cards

  Geared toward those with poor or limited credit, secured credit cards require a refundable cash deposit upfront to open your account. This security deposit acts as collateral and usually determines the amount of your line of credit. You can get your security deposit back if you pay your balance in full and close your account or if you graduate to an unsecured card.

  Check out our list of the best secured credit cards.

• Business credit cards

  Business credit cards give business owners access to credit. These cards often offer accelerated rewards on business-related purchases as well as tools to help manage business spending. They may also provide higher credit limits than personal credit cards. When you apply for a business credit card, many issuers will check your personal credit and ask for a personal guarantee in case you default. However, there are a few business credit cards that don’t require a personal credit check.

  Check out our list of the best business credit cards.

• Student credit cards

  Student cards give students access to a revolving line of credit. Because these cards are available to students with limited or no credit, they tend to offer lower credit limits and limited rewards programs and benefits compared to traditional credit cards. But when used correctly, they can serve as a great tool to help establish or build credit.

  To be eligible for a student card, you may need to show proof of part- or full-time enrollment in an accredited university.

  Check out our list of the best student credit cards.

• Store credit cards

  Store credit cards can usually only be used to make purchases and earn rewards at one particular retailer or network of retailers. These cards are typically easier to get approved for than traditional credit cards. However, they often come with high APRs and low rewards-earning potential.

  Read more about the different types of credit cards.

When you pay for goods or services with a credit card, you’re borrowing money from a bank or credit union. You have a credit limit, which controls how much you can borrow at any given time, and you’ll have to pay back what you borrow.

Most credit cards have a grace period, which means you won’t pay interest if you pay your balance in full by the due date. But if you just make the minimum payment and carry a balance over to the next billing cycle, you’ll owe interest on that balance.

Using a credit card to make purchases can provide several benefits, including helping you:

• Build your credit. When you use your credit card responsibly — meaning, you pay your bill on time each month and stay well below your credit limit — you can establish a positive credit history. Be aware, though, that the issuer will need to report your account and payment activity to the three major credit bureaus (Experian, Equifax and TransUnion) for you to get credit for your responsible usage.Check out our picks for the best credit cards to build credit.
• Protect your money. If there’s an unauthorized or incorrect charge on your account, a credit card provides a layer of protection, since it doesn’t pull money immediately from your bank account.
• Safeguard against fraud. It’s typical for credit cards issued in the United States to offer zero fraud liability. This means you generally won’t be responsible for paying fraudulent charges on your account.
• Earn rewards. If you have a rewards credit card, you can earn points, miles or cash back when you use the card to make purchases. These rewards can be used to help offset the cost of future purchases or an annual fee.
• Get access to benefits and protections. Some credit cards provide valuable benefits, like annual credits or free access to your credit score. Some also offer protections, like purchase protection or extended warranty protection, to cover eligible items you purchase using your card.

If your credit offers a grace period (usually around 21 to 25 days between the close of your credit card’s billing cycle and the due date on your statement), you won’t be charged interest as long as you pay your credit card in full by your payment due date. But if you carry a balance on your card from one month to another, you’ll be charged interest at the card’s current annual percentage rate (APR).

Most credit cards have variable APRs, meaning that issuers can increase or decrease them at any time. Typically, issuers will base credit card APRs on an index, like the Prime Rate. According to a recent LendingTree study, the average APR for new credit cards was 24.71% as of May 2024.

Credit cards may come with several types of APRs:

• Purchase APR: This is the interest rate you’ll be charged for purchases you make using the card.
• Balance transfer APR: This is the interest rate you’ll be charged when you transfer an existing credit card balance to the card.
• Cash advance APR: This is the interest rate you’ll be charged if you use your card’s line of credit to access cash. The cash advance APR is typically higher than the purchase or balance transfer APR. Plus, cash advances don’t have grace periods — so you’ll start incurring interest immediately after withdrawing your cash.
• Penalty APR: If you pay your bill late by 60 days, your APR could increase — sometimes as high as 29.99%. Depending on the issuer, this penalty rate could be permanent or only last up to six months.
• Promotional APR: Some cards offer a low or 0% APR on purchases and/or balance transfers for a period of time after opening your account. Depending on the card, this intro period could last up to 21 months. While you won’t be charged interest during this time (even if you carry a balance on your card from month to month), you will be subject to interest charges at the regular rate once the intro period ends.

Here are a few common credit card fees that your credit card issuer may charge:

• Annual fee — Some credit cards charge an annual fee ranging anywhere from $95 to $695. Usually, the cards with higher annual fees offer more generous rewards programs and provide more robust benefits and protections.
• Balance transfer fee — Most balance transfer cards charge a balance transfer fee of 3% or 5% of the amount of each transfer (with a $5 or $10 minimum). While there are a few cards available with no balance transfer fee, those are usually issued by credit unions that require membership.
• Late payment fee — If you pay late, the majority of credit cards will charge a late fee. The amount of the fee may vary depending on the credit card issuer, but it could be up to $30 for the first late payment and up to $41 for a second missed payment within the same six months. That said, due to a recent ruling from the Consumer Financial Protection Bureau (CFPB), you could only be subject to a late payment fee of up to $8.
• Cash advance fee — Credit card cash advances are typically subject to a cash advance fee of around 5% of the amount of each transaction.

The main difference between a credit card and a debit card is that a credit card incurs debt, while a debit card draws funds from your checking account. That said, each has its pros and cons:

	Pros	Cons
Credit card	Buffer that protects your checking account Builds credit history with the credit bureaus Typically have robust zero fraud liability	No issuer approval needed Can help avoid overspending
Debit card	Usually requires a hard inquiry and issuer approval Can incur interest charges May be tempting to overspend	Spends money directly from checking Doesn’t build credit history Could incur overdraft fees You could be liable for up to $50, up to $500 or even the full amount of fraudulent charges, depending on how soon you report the fraud

Ultimately, a credit card is the better choice if you want to build your credit profile, earn rewards, take advantage of a 0% intro APR offer or get access to purchase and travel protections. On the other hand, a debit card may be ideal if you need access to cash or if you have a history of overspending and only want to spend funds you currently have available in your bank account.

Once you determine which credit card you want, you can apply for it online, in-person at a bank branch, over the phone or by mailing in an application. Depending on the card, you may be asked to provide personal and financial information, including your full legal name, date of birth Social Security number (SSN), residential address, annual gross income, employment status and housing costs.

After you submit your application, you may receive an approval or denial within minutes. Or, the issuer may place your application under review — which just means they need more time to evaluate your application.

To avoid racking up debt and putting a big dent in your credit score, it’s extremely important to use your credit card responsibly. Once you’re approved for the card, be sure to follow these four primary rules:

1. Always pay your bill on time and in full whenever possible, since payment history is the most important factor making up your credit score. Along with damaging your credit score, missed payments can initiate late payment fees as well as a penalty APR.
2. Stay well below your credit limit. Your credit utilization ratio (the amount of debt you’re carrying relative to how much you can borrow) is the second most important factor contributing to your credit score. To keep this low, experts recommend only spending up to 30% of your available credit limit.
3. Only charge what you can afford to pay off each month. Otherwise, you’ll risk racking up a large amount of debt and interest charges.
4. Monitor your monthly credit card statement for potential mistakes and fraudulent activity. Checking your account can also help you keep track of your spending to ensure you don’t go over budget.