How Credit Cards Work: A Simple but Complete Guide

How Credit Cards Work: A Simple but Complete Guide
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Point Editorial

Credit cards and debit cards are two tools for spending money. Both are convenient, both are great substitutes for carrying cash, and both exist in various forms.

Using a credit card helps you build up your credit history and credit score. This is crucial for achieving larger financial goals down the line, whether you're making a down payment on a house, buying a new car, or taking out a student loan. 

Read on to learn more about credit cards, how they compare to debit cards, and their advantages and disadvantages.  

What is a credit card for?

Credit and debit cards may be similar in appearance, but they differ in multiple ways —  primarily in how they can be used to access money. 

Credit and debit cards are both small, thin pieces of plastic that allow you to make purchases and payments both online and in-person. They also allow you to withdraw cash from ATMs.

Credit cards, specifically, have predetermined spending limits. This means the issuing credit company will lend you money up to a certain amount, and exceeding that limit results in penalties and fees. 

Cardholders must consistently repay any purchases, with a minimum balance due monthly. The total amount someone owes on a credit card is called a credit card balance.  

How does a credit card work?

Whenever you make a purchase, the retailer sends your credit card details to their banking institution. From there, the credit card network approves and processes the transaction.

Once the credit card company officially verifies the purchase, it will appear on your credit card statement. Depending on the card's terms and conditions, you must repay your card's balance during each billing cycle, either partially or entirely.

Credit companies send cardholders notifications that outline the exact date when payments are due, how much the cardholder owes, and when the next billing cycle begins. The period leading up to the due date is known as the grace period. 

A credit card's annual percentage rate (or APR) represents the costs of owning the card. This includes a fee for yearly usage, interest rates, and, if applicable, a charge for certain types of transactions and withdrawals. 

Interest and late fees accrue if cardholders miss a payment due date, either accidentally or intentionally. If this behavior continues, the interest will compound, and the balance will be more difficult to liquidate. This can also negatively impact a person's credit score. 

Types of credit cards 

Described below are the four general types of credit cards. 

Interest-free 

An interest-free credit card means that you won’t be responsible for paying APR and interest on charges for a limited period, usually six to 18 months. This is called an introductory period.

Balance transfer

A balance transfer card allows you to move debt from one credit account to another, usually one with a lower interest rate, or no APR, period. This can be a smart way to save money as you repay your balance.

Keep in mind that in using a balance transfer card, however, you may be subject to a transfer fee. 

In most cases, acquiring this type of card requires an attractive credit history.

Student cards

Despite the name, student cards are not exclusive to university students. Individuals 21 and younger who have little to no credit history are the typical recipients of this type of card. Those who cannot provide proof of stable or established income must have a cosigner. 

Rewards cards 

Rewards cards give you something in return for every purchase you make, whether it's cash-back, travel points, or store credit. Rewards cards are more difficult to obtain, and are usually only given to individuals with high credit scores who have demonstrated their ability to pay their bills consistently each month. 

Things you should know about credit cards

Outlined below are pointers to be aware of before applying for a credit card.

Tip 1: Know that the credit company will conduct a hard inquiry of your credit history. Having a good credit rating will improve your chances of approval and vice versa. Regardless of your score, hard inquiries are recorded in your file and remain on record for approximately two years. If multiple hard inquiries are made, especially within a short period, your score may decrease. 

Tip 2: If a credit company approves you, you must adhere to a predetermined credit limit. 

Tip 3: At the very least, you must make your minimum monthly payments. Again, missing payments will lead to a rise in interest charges and additional penalties, severely harming your credit score. 

Tip 4: In most cases, you must be at least 18 years old to apply for a credit card. 

Credit card pros and cons 

Advantages 

One: They're flexible. Credit cards allow you to make purchases with a grace period before you have to repay your balance. This can be especially helpful with large purchases — such as electronics or home improvements — or in the case of an unforeseen emergency.

Two: They're easy to carry. Besides being more convenient than cash, thanks to their size, they're very straightforward to use. After all, all you need to do is tap or insert upon making a purchase. What’s more, they're much safer than keeping large bills in your wallet.. 

Three: They offer fraud protection. Most credit cards provide some form of fraud protection, though this protection can vary depending on the card type. See below for more details. 

Four: When used responsibly, they can help you build credit. 

Disadvantages 

One: They come with additional fees. While you may not have to pay interest fees, other charges — like those that come with exceeding your credit limit, withdrawing cash, or transferring money — can be costly. 

Two: Debt can build up quickly. Interest will start to add up each time you fail to make a payment. Even over a relatively short period, this can cause your debt to spiral out of hand. 

Three: They can damage your credit score if misused. This can affect your ability to borrow money down the road. 

Four: They can be expensive to use abroad. Again, this depends on the type of card. Not every card offers travel perks like free international transactions.  

Credit cards versus debit cards 

Credit cards 

When paying with a credit card, it's essential to remember that you're not using your own money. Instead, you're borrowing from the credit company to make purchases that you must pay back at a later date. Cards also come with mandatory monthly minimum payments. 

Credit card activity impacts your credit score. This information goes to one of the three major credit bureaus: Experian, Equifax, and TransUnion. They record your payment history, credit utilization, the length of your credit history, the diversity of your credit accounts, and applications for new credit — with each factor making up a percentage of your total credit score. 

On the other hand, there are more protective measures in place when spending with credit cards. The Fair Credit Billing Act says you are only liable up to $50 for suspicious purchases with a credit card. You're also not responsible if someone steals your credit card number. 

Debit cards 

When using a debit card, you spend your own money, as the card directly draws from your personal checking account. Since there is no borrowing involved, there are no monthly payments. 

Debit cards do not impact your credit score. 

The degree of debit card fraud protection can vary, and the amount of applicable liability depends on how soon you report the lost or stolen card. The breakdown, relative to time, is below.


Time Liability
If you report the missing card immediately   Zero liability
If reported within two business days   Liable for up to $50
 If reported after more than two business days Liable for up to $500 
 If reported more than 60 days later  Liable for covering every suspicious charge

Point Card

A third alternative spending card that exists alongside traditional credit and debit cards is Point Card

You work hard for your money, and Point works hard for you in return. Point Card is a transparent payment card for those who want to use their earnings and receive exclusive benefits, including unlimited cash-back on all purchases. Point Card includes multiple safety nets that help to build wealth and ensure monetary stability, such as fraud protection with zero liability, no interest rates, and rental car and phone insurance. Point members are also eligible for bonus cash-back on subscriptions, food delivery, rideshare services, and coffee shops. 

Point is a great tool for intelligently navigating your financial journey, regardless of your present circumstances. While classic credit and debit cards are highly viable options for many, it is always good to know that accommodating, personalized options that cater to you and your preferences are out there as well.

Costs of carrying a credit card

Credit cards can incur charges in multiple ways, and it is wise to be familiar with them. 

One: They usually involve interest rates. Different cards have different rates. 

Two: They come with ATM fees. If you withdraw cash from an ATM not associated with your card, you will most likely have to pay a small fee. Experts recommend that you avoid taking out money on a credit card unless you do it at your local bank. 

Three: Balance transfers have fees. The card company will most likely charge 2–4 percent to transfer a balance to another card. 

Four: Credit card checks also involve fees. A credit card check is practically identical to a traditional check, except the money is charged to your credit card bill, and you’ll have to pay that back as part of your monthly statement. Similar to cash withdrawals, you may have to pay a fee to this, so it is wise to avoid writing these if you can.

Five: Some cards come with an annual cardholder fee. While many cards do not charge a flat rate yearly, others do, especially if they offer more benefits than the average card, like rewards programs and higher credit limits. 

How to build credit

Step 1: Make your payments on time. This is arguably the best and the easiest thing for you to do. Payment history accounts for 35 percent of your credit score, so paying off your balance will indeed boost your score. 

Step 2: Keep your credit card balance low. Using too much or exceeding your credit limit does not reflect well on your history. Experts recommend that you try and keep your balance below 30 percent of your available credit to be safe.

Step 3: Get a credit limit increase. Asking for a higher credit limit can help keep you from falling into trouble regarding your credit amount. That said, it can also lead to overspending, so always be aware of your spending habits and use your credit card responsibly.

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Point Editorial
A group of writers, thinkers, & designers from varying backgrounds — all part of the Point Card team. Sharing perspectives on concepts in design, finance, and culture through an everyday lens.
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