Credit Card Basics for Beginners

 

How Do Credit Cards Work?

A credit card gives you an opportunity to pay for purchases on credit. You get a grace period, which is usually between 21 and 25 days. If you pay by your balance during the grace period and by the due date, you don't pay any interest.

Have you ever wondered what happens behind the scenes after you use your card for payment? It's actually fascinating – and quite simple!

Here's a brief recap of a credit card transaction's journey when you buy, for example, a pair of shoes at your favorite store:

1. You use your credit card to pay for your new shoes. Your credit card information is sent to the retailer's bank, also called the acquiring bank.
2. The acquiring bank requests payment authorization. The request is made to the credit card network for your credit card. These are the payment networks: Visa, Mastercard, Discover and American Express.
3. Your purchase is authorized. The amount you paid for your shoes decreases your credit limit by that amount.
4. You pay for your new shoes. The purchase amount shows up on your credit card statement. You're given a due date and the amount of the minimum payment you must pay. If you pay the full balance, you don't have to pay interest.

How Is Credit Card Interest Calculated?

When you pay your entire balance each month, you're replenishing your available credit. If you only make the minimum payment, you risk getting into credit card debt. This is important to know because credit card balances are subject to compound interest, which makes your debt get larger pretty quickly.

Most credit card issuers compound interest on your balance at the end of every day. Over time, you end up paying interest on your interest! Just don't go there.

Think of your credit card as a way to get a short-term interest-free loan. You pay your balance off during the grace period, and you essentially get to have your purchases for a few weeks before paying for them.

Types of Credit Cards

I know it can feel overwhelming when you're trying to select a credit card. There's such a wide range of choices out there. I want to make it easy for you, so here's a quick breakdown of the different types of credit cards:

Student Credit Cards

If you're a college student looking for your first credit card, a student card can be a good choice. Many student cards offer benefits such as cash back rewards, incentives for good grades and free credit scores. According to the Credit CARD Act of 2009, cardholders must be at least 21 years old or show proof of adequate income.

Credit Cards for Bad Credit

If you have a FICO score below 580, you are considered very risky by credit card companies. People who fall within this credit range typically don't get approved for traditional credit cards. You might qualify for unsecured credit cards for bad credit, but many of these cards come with fees and high APRs. Be sure you carefully read the fine print to understand how much you could pay to use a card.

Secured Credit Cards

These cards are a good way to establish or rebuild your credit. Secured cards require a cash deposit, which is usually between $200 and $2,500, but some issuers allow larger deposits for those who want a higher credit limit. Your deposit decreases the risk for the lender, but you're still buying items on credit. When you close your account or switch over to an unsecured account, you get your deposit back unless you have an unpaid balance.

Balance Transfer Cards

If you have credit card debt but still have a good credit score, getting a balance transfer credit card can help you save money on interest. The best cards offer a 0% introductory APR for a specified period of time, ranging from 15 to 21 months. Balance transfer credit cards often charge a transfer fee, usually between 3% and 5% of the balance transferred.

0% APR Credit Cards

Noted above, there are credit cards that offer 0% APRs on balance transfers. But there are also cards that have a 0% introductory APR offer on purchases. Some credit cards even offer a 0% APR on both balance transfers and purchases. Always read the terms carefully. Sometimes, the introductory period for balance transfers and purchases isn't the same. When the intro period ends, you'll get the regular purchase APR assigned by your issuer.

Small Business Credit Cards

These cards offer management tools that consumer credit cards don't have. Many small business cards also have generous rewards that cover the type of expenses you incur when running a business. But be aware that the Credit CARD Act of 2009 doesn't offer the same consumer protections for business credit cards.

Credit Cards to Build Credit

You can build a solid credit history – and credit score – by using credit cards responsibly. Whether you're new to credit or you're rebuilding your credit, here are some credit cards that can help you.

• Secured credit cards. These cards offer you a chance to establish a good credit score or even fix a bad one. You do have to put down a deposit, but if you use the card responsibly, you'll get your deposit when you're ready to get an unsecured card.
• Student credit cards. If you're a student, this can be a good option. You do have to show proof that you have an income if you're younger than 21.
• Cards for bad credit. The FICO score range for poor credit is 300 to 579.
• Cards for fair credit. The FICO score range for fair credit is 580 to 669. Once you enter the land of fair FICO scores, you get better credit card options.

Rewards Credit Cards

A rewards credit card can have a range of rewards, such as cash back, points or miles. These cards also come with a variety of ways to redeem your rewards, including statement credits, travel and merchandise. And some cards offer additional points in bonus spending categories such as gas, dining, online stores and groceries.

By the way, I used airline miles to pay for two first-class round-trip tickets to Maui later this year. The best part of earning rewards is using them!

Here's a brief description of the different types of rewards credit cards:

Cash back credit cards. If you want to save on everyday expenses, a cash back credit card might be the card for you. You can earn rewards on a range of categories. You'll often get a different rewards rate for each category. For example, you might get 3% cash back on grocery purchases, 2% back at gas stations and 1% back on other types of spending. Some cash back cards have rotating categories that change quarterly.

Travel rewards credit cards. General travel rewards cards have flexible options. For example, you can choose the airline to redeem rewards with, instead of being required to book your flight with a specific airline.

Airline-branded cards. As the name suggests, these cards are tied to a specific airline. A general travel rewards credit card is best if you need flexibility. But airline-branded cards have excellent rewards and can be a good choice if you have a favorite airline.

Hotel-branded cards. These credit cards are tied to a group of specific hotels and often have generous rewards and perks. If you have a favorite hotel, a hotel-branded card can be an excellent option..

How Credit Card Rewards Work

Now that I've explained the types of credit card rewards that are available, let's talk more about how they work.

Rewards credit cards allow you to earn points, miles or cash back for every dollar you spend. Whether your card's rewards are labeled as points, miles or cash back doesn't necessarily determine how you can redeem them. You may be able to redeem for travel, cash back, merchandise or other options, depending on your card. Rewards cards can be an excellent way to earn on your spending, as long as you don't carry a balance.

Most rewards cards entice new customers with a sign-up bonus. You can earn a sign-up bonus, often worth hundreds of dollars, if you spend a certain amount on the card, usually within the first few months of opening your account.

What Credit Card Should I Get?

You need to do three things before you start researching credit cards:

1. Know your credit score. Your credit score helps you determine which credit cards you might get approved for. This keeps you from applying for cards that aren't within your reach yet. For instance, if you have fair credit, you won't get approved for a card that requires excellent credit.
2. Look at your budget. If you want a rewards credit card, review your expenses in your budget. You can profit from credit cards if you earn rewards that match your spending patterns.
3. Decide what type of credit card you need. Look in your wallet and see what type of card you lack. If it's your first card, you'll be focusing on credit cards that are used for building credit. But if you have several cards, you might want to add a rewards credit card that offers rewards that your current credit cards don't. For example, if you have a travel rewards card, you could consider getting a cash back credit card to help you save on everyday expenses.

I have five credit cards that I use strategically. This means I use the right rewards card whenever I buy something. If I'm buying groceries, for example, I use the card that gives grocery rewards. I earn thousands of dollars in rewards every year by doing this. You can, too.

Comparing Credit Cards

When you know what credit card category you want to pursue, compare cards within that group that would meet your needs. For each credit card, take a look at the following:

• Purchase APR. This is the APR on purchases made with a credit card. Paying your balance in full every month is best, but you'll still want to know a card's APR to see if it's high compared with other cards in that category.
• Balance transfer APR. The best balance transfer cards offer a 0% introductory APR. Those with lower credit scores might not qualify for cards with a 0% APR. But you still might find a balance transfer card with an APR that's lower than what you have now. You also need to compare balance transfer fees, which are usually 3% to 5% of each transfer, as well as the length of the 0% APR offer, if there is one. Most 0% APR cards offer between 12 and 21 months.
• Annual fee. Rewards credit cards may have annual fees. Before you choose a card with an annual fee, estimate how much you'll earn in rewards with the credit card. Then subtract the annual fee to see if you still come out ahead. Your goal is to get a rewards card that helps you make a profit.
• Cash advance terms. Look at the transaction fees, which are usually 2% to 5%. And compare the cash advance APR for each card. It's usually higher than the purchase APR. You should know that there's no grace period with cash advances, which means that interest starts accruing immediately. A cash advance is an expensive way to borrow money.
• Foreign transaction fees. Many credit cards charge this fee when a purchase is processed outside of the U.S. It's usually about 3%.
• Other fees. Read the fine print to know how much the issuer charges for late fees, paper copies of statements and so on. Credit cards that target people with bad credit sometimes charge application fees and even monthly maintenance fees.
• Rewards programs. These programs differ greatly. Compare the cards you're interested in to find the best fit.
• Perks and benefits. Featured perks might include waived baggage fees, priority boarding privileges, purchase protection for eligible items, cellphone insurance plans and in-flight credits. Many cards also offer sign-up bonuses to new cardholders. Cards with annual fees usually have robust rewards and better-than-average perks and benefits.

How to Apply for a Credit Card

Before you start the application, you need to have access to a few things. Be ready to report your gross annual income for the application. Credit card issuers need to know your income so they can determine if you can repay any debt you accumulate. Your income is also a factor when the issuer is setting a credit limit.

And be sure you're applying for a card that's in line with your credit score. You can find free scores in multiple places, such as on your credit card statement or from your bank. Also have your personal information handy, including your Social Security number. Got everything? OK, you're ready to start the application.

Here are the four basic steps of applying for a credit card online:

1. Fill out the application. You'll be asked for your name, Social Security number, birthday, home address, email address and other identifying information. Also, you'll need to list your employer and annual income. This information helps the issuer determine whether you have enough income and job stability to pay off balances you incur with the credit card.
2. The issuer will review your credit report and credit score. Along with your application, your credit report gives the issuer an overview of your payment history, current accounts and debt, plus any negative items that pop up, such as a delinquent account. Your credit score also reflects your creditworthiness and is another tool used to determine whether your application should be approved.
3. Wait for a response to your application. If approved, you'll receive your new credit card within about 10 business days. When you get the card, you can activate it by going online or calling the provided number.
4. What to do if your application is denied. If denied, you will receive an adverse action letter stating the reason. You could be denied credit for many reasons. For example, you might have too many inquiries on your credit report, a credit score that's too low or insufficient income.

Use the adverse action letter as a blueprint for improving your credit. But if you feel that you'd like to discuss the matter, call the issuer's reconsideration line. This number is often contained in the adverse action letter. If not, call the customer service number and ask to be connected with the credit card reconsideration department. Before you call, prepare to address the issues raised in the letter.

How Many Credit Cards Should I Have?

You should have the number of credit cards that you need – and not more than that. I mentioned that I make thousands of dollars in rewards every year by strategically using five credit cards. And that's not counting welcome offers.

If you can manage credit responsibly, you can also benefit from carrying more than one credit card. With multiple cards in different categories, you can earn many rewards and enjoy the perks and benefits that come with your cards. Using several cards responsibly can also help you build a strong credit history.

Remember I said not to have more than you need? For some, having too many cards makes it difficult to track rewards and even pay the bills on time. If you start carrying a balance, step back from the cards and determine the reason. You want to profit from your cards, not get into credit card debt.

What Is the Best Credit Card Issuer?

The best credit card for you depends on factors including your credit score and whether you are interested in rewards. You can check a company's ratings with the Better Business Bureau and Trustpilot and search for it in the Consumer Financial Protection Bureau's Consumer Complaint Database to get a sense of its reputation.

Keep in mind that credit card issuers are the companies that provide cards, while credit card networks authorize and process credit card payments. The payment networks are Visa, Mastercard, Discover and American Express. Note that Discover and American Express are both credit card issuers and credit card networks.

Best Credit Cards Methodology

Our team of experts uses a data-driven methodology to rate credit cards in various categories. Our goal is to help you identify the credit cards most likely to fit your needs.

Credit cards in each category are scored using an unbiased, complex algorithm that reviews multiple factors, including APRs, annual fees, types and flexibility of rewards programs, sign-up bonus values, benefits and issuer satisfaction ratings to determine what cards come out on top.

Credit Card FAQs

What Is the Best Credit Card?

The best credit card is the card that best fits your spending habits and needs. If you have a high credit score, then you can probably get approved for almost any card you want. Start by choosing a card type, such as rewards credit cards that earn points, miles or cash back rewards for your spending. Look at which cards within that category will provide the best value, and check for complaints about the credit card company filed with the Consumer Financial Protection Bureau. On the other hand, if you want to build or rebuild credit, you may want to consider credit cards for bad credit and secured credit cards. You should also make sure the card reports to all three credit bureaus.

What Is the Easiest Credit Card to Get?

Secured credit cards, student credit cards, store credit cards and alternative credit cards are the easiest cards to get for consumers with bad credit or no credit.

How Credit Card Interest Works

Your credit card company will set your interest rate based on your creditworthiness. With credit cards, your rate is called the annual percentage rate, or APR.

The interest rates and fees can be found in the Schumer box at the top of your card's terms and conditions.

You can also check the credit card's page on the issuer's website for a link to rates and fees, pricing and information, pricing and terms, or another similar phrase.

Most major credit card issuers offer a grace period, which is usually around 21 to 25 days, before you need to pay your bill. This is the amount of time between when the billing cycle ends and when the payment is due.

If you pay the balance in full by the due date, you don't pay any interest. But if you carry a balance, the payment for the next month will include compound interest on the balance. In effect, you'll be paying interest on your accumulated interest. For this reason, credit card debt can grow at a fast rate.

Even if you don't plan to carry a balance, life is unpredictable and you may have a financial crisis that takes a few months to pay off. So it's always better to have an interest rate as low as possible. The way to get approved for low interest rates is to get your credit score as high as you can.

What Is a Credit Report?

Your credit report contains personal data, credit account history, credit inquiries and any negative items, such as a collection account or a bankruptcy. When you apply for credit, your credit report helps lenders gauge your creditworthiness. Check your credit report for free before you apply for a credit card.

Should You Get a Credit Card for a Big Purchase?

If you plan to make a big purchase and would like to spread out the payments to make them more affordable, consider using a credit card with a 0% introductory purchase APR. A 0% APR credit card lets you pay for a purchase over many months without owing interest on the balance. The length of 0% offers varies, but it typically ranges from 12 to 21 months. It's a great opportunity to pay less interest, but if you don't make payments on time, you could lose the 0% introductory rate.

How Long Does It Take to Get a Credit Card?

You can get approved for and start using some cards instantly, but others could take more time. Approval may be delayed if you have a credit freeze in place or are requesting a large credit limit. Your physical card will usually arrive seven to 10 business days after approval. If you need the card quickly, check whether the issuer offers expedited shipping or can provide the card number or digital wallet access.

What Is a Credit Score?

Your credit score is a number that measures your credit risk and reflects how well you use credit. When you apply for credit, a credit card company requests your credit score and reviews your credit report. Both FICO scores and VantageScores range from 300 to 850. The average FICO score is 716.

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