Credit Cards: How on Earth do They Work?

Credit cards.

They are everywhere–offers in your mail, your email, social media, even at a clothing store. Credit cards are one of our favorite things to use–and yet, we often are not great at it!

It’s understandable that credit cards are hard to use because they are. I can’t begin to tell you how long it took me to understand what I signed up for. When it comes to signing up for a credit card, though, you should really understand what you taking responsibility for. Even though there are many ways misusing credit cards can affect your credit in a bad way, you can use them responsibly.

Even when we want to escape credit and avoid debt, the reality is that our culture not only encourages us to spend but makes it the only option to get ahead. Credit cards are the only way to start building credit efficiently, so even if you like to avoid debt, it is a tool you will need in order to get the things you already want–like a house, a car, or even get approved for an apartment lease.

What is a credit card?

A credit card is what is called in the financial world a revolving credit tool. Unlike a loan, you don’t use the whole credit card limit all at once, but in separate transactions.

Every time you use a credit card you are essentially taking out a loan in that amount using the bank’s money.

What is a credit card limit?

A credit card limit is the maximum amount the bank is willing to loan you. On your first credit card this might be low–usually less than $1,000–but as the years go on, and if you are good at using your card responsibly, this limit may increase.

Even though the bank is allowing you to use all of this money, that doesn’t mean you have to. Try to keep your credit usage low–usually to the extent of what you can pay off in full at the end of each month.

What’s a credit card balance?

A credit card balance is the amount of money you have currently spent using the credit card, which you have not yet paid off. In an ideal world people never carry of balances and everyone’s happy, but the reality is that this is not always possible. Avoid carrying a balance when you can, but if you absolutely have to, have a plan to pay it back as soon as possible to avoid further interest being accrued on your account.

What’s a minimum payment?

When your statement is due, there is a line that tells you your minimum payment. This is the payment that will keep your account in good standing. Always have your minimum payment on autopay. This will ensure your payments are never late (which is a very bad thing!).

You should never just rely on making the minimum payments, though. Ideally, you want to pay off your balance in full every month. If you can’t, still pay whatever you can above the minimum payment which will reduce the amount of interest that you have to pay.

What is credit card interest? 

When you carry a balance from one statement to the next, the bank will charge you a fee for carrying that debt–this is called a credit card annual percentage rate (APR). The lower your APR, the better! This means you will not accrue large amounts of interest if you do have to carry a balance. An average APR is around 15%.

What about all these other fees?

Banks love to penalize you for being late, but they also charge you fees to access their other services associated with your credit card:

  • Late fees. If you’re late, you pay! It’s usually a set amount and the one that it’s the easiest to fall into.
  • Annual fees. Some credit cards charge you an annual fee for having an account open with them. Basically, this is the bank charging you a fee for having an account open with them–read what you are signing up for so you don’t get these.
  • Balance transfer fees. This is a charge that is put on you when you use one credit card to pay the balance of another credit card. Not for the faint of heart!

What’s the best place to get a credit card?

Usually, people get their credit card at a bank or a credit union–this is our favorite way to get a credit card. Store credit cards are not something our office recommends, simply because they tend to have significantly higher interest rates than cards from banks or credit unions.

Having a credit card is a huge responsibility! It’s money you always have to pay back. If you use it wisely it can bring you huge benefits down the road–like when you apply for a new job or get a new car.