How do credit cards function?

Whether you're a newcomer to credit card rewards or have multiple credit cards, you're probably here to learn more about their operation.

This article will begin at the basics and guide you through some fundamental credit card concepts.

What exactly is a credit card?

A credit card is a tangible card, crafted from plastic or metal, that enables you to make purchases using borrowed money. Unlike a debit card, which uses funds directly from your bank account, a credit card allows you to borrow money. Additionally, credit cards accumulate interest on the borrowed amount if you do not pay the full balance by the monthly due date.

Credit cards play a significant role in your credit score, which reflects how effectively you manage your credit responsibilities. A better payment history, among other factors, contributes to a higher credit score.

Your overall financial situation and robust credit history can qualify you for premium credit cards, enabling you to earn reward points based on your spending. These cards typically offer higher limits and additional valuable benefits.

What is the process of credit card usage?

Credit cards enable users to borrow funds up to their credit limit repeatedly over an indefinite period. As long as your account remains in "good standing" with a solid payment history, it will remain active.

If you're unable to pay off your entire credit card balance — which we always suggest — you must at least make a minimum monthly payment to avoid late fees. The average annual percentage rate (APR) for credit cards exceeds 20%. Consequently, carrying a balance can lead to substantial costs over time as your debt accumulates.

Being aware of this is crucial to prevent your debt from spiraling out of control, which can negatively impact your credit score.

What is the mechanism of credit card interest?

Credit card interest is expressed as an APR, representing the total annual cost of borrowing as a percentage. Credit cards can have various types of APR, with the most prevalent being purchase APR.

The purchase APR refers to the interest rate applied to purchases — essentially, the standard interest rate. Understanding your purchase APR is crucial for effectively managing your credit card balance and reducing borrowing costs. You can find your APR by checking your credit card statement or logging into your account online.

Other forms of credit card APR include cash advance APR (the interest rate applied to cash advance transactions) and penalty APR (a higher APR that may be imposed if you go over your credit limit or miss payments).

What is the process for credit card payments?

Credit card issuers generally offer four methods for paying your monthly credit card bill: making a minimum payment, settling the statement balance, paying the current balance, and choosing a custom amount.

The minimum payment is simply the smallest amount you need to pay to keep your account in good standing. The statement balance represents the total charges made during the last billing cycle.

The current balance reflects the total amount spent so far (essentially, what you've charged since your last payment, minus any recent pending charges). Additionally, you can choose to pay any custom amount you prefer.

What are the various types of credit cards available?

There are various types of credit cards available, and below are some of the most prevalent categories.

General travel cards

General travel credit cards allow you to earn rewards for future travel and provide benefits that aren't limited to any specific airline or hotel brand. These rewards are usually transferable and offer great flexibility. Typical perks include complimentary travel insurance, TSA PreCheck and Global Entry credits, as well as access to airport lounges.

For our top selections, check out our complete list of the best travel credit cards.

Airline cards

Airline credit cards are associated with a particular airline and allow you to earn rewards in that airline's points or miles currency. You’ll also benefit from perks such as free checked bags, automatic elite status, and access to airport lounges.

To discover our top picks, take a look at our comprehensive list of the best airline credit cards.

Hotel cards

Hotel credit cards are associated with a specific hotel brand and earn rewards in the form of loyalty program points, which can be redeemed at any hotel within that brand. Benefits may include complimentary nights and automatic elite status in the hotel’s loyalty program.

For excellent choices, explore our compilation of the best hotel credit cards.

Cash-back cards

Cash-back credit cards enable you to receive a percentage of your spending back in cash. You can redeem these cash rewards, typically as a statement credit. Many cash-back cards also offer additional benefits like insurance coverage, discounts, and access to special promotions.

To discover some of our top cash-back card recommendations, check out our list of the best cash-back credit cards.

Secured cards

Secured credit cards are tailored for individuals with limited credit histories or lower credit scores. When you open a secured card, a security deposit is required, serving as collateral for the card issuer.

Secured credit cards generally do not offer rewards but are an excellent option for establishing or rebuilding your credit history.

For more information, check out our list of the top secured credit cards.

Business cards

Business credit cards assist entrepreneurs in managing their business finances. With a business credit card, you can keep your business and personal expenses separate, provide team members with employee cards for convenience, and earn valuable travel and other rewards on your business-related spending.

If you are an entrepreneur, freelancer, or small business owner, take a look at our list of the best business credit cards.

Student cards

Lastly, student credit cards are tailored for college students aiming to build credit and foster sound financial habits. Similar to secured cards, these student cards typically offer limited rewards, but they provide a fantastic entry point for young individuals into the realm of credit cards.

For various student-friendly credit card choices, check out our list of the best credit cards for college students.

How to select the ideal credit card

The best credit card for you will hinge on your spending patterns and financial aspirations. Chances are, whether your aim is to establish credit, accumulate cash back, or earn travel rewards, there's a card that aligns perfectly with your objectives.

Begin by identifying what you aim to achieve by obtaining a credit card. This will allow you to refine your options and select a credit card that aligns best with your requirements.

Final thoughts

Credit cards, particularly those that offer rewards, can appear complicated and intimidating. However, by grasping their functionality, you can discover the card that will assist you in managing your expenses and progressing towards your financial objectives.

Always remember to utilize your credit card wisely and steer clear of overspending — strive to pay off the full balance punctually each month.