Credit cards are valuable financial tools that enable you to make purchases you can pay off over time. Some credit cards provide other valuable perks just for using them. In 2020, 83% of Americans owned at least one credit card, according to the Federal Reserve.
Despite their popularity, credit cards can be confusing, leaving you with many questions. Let’s answer your most frequently asked questions to help you understand how credit cards work and maximize their value.
How do you open a credit card account?
You can open a credit card account by filling out an application at a bank, credit union or online. You’ll need to show that you’re a U.S. resident over 18 with a Social Security number (SSN) or Individual Tax Identification Number (ITIN).
As part of the application process, you’ll likely have to provide information about yourself, including your income and employment status. Typically, the credit card company will also want to pull your credit report to help them evaluate your creditworthiness before approving your application.
Credit card basics for beginners
Credit cards can help you build credit, among other benefits. If you’re a first-time credit card user, establish positive habits like paying your bill on time and keeping your balances low to establish and grow your credit.
Keep in mind, that your payment history accounts for 35% of your credit score, according to FICO. Similarly, your credit utilization ratio — the percentage of your credit limit you’re using — makes up 30% of your credit score. So, if you have a $250 balance on a credit card with a $1,000 limit, your credit utilization ratio is 25%.
It’s widely recommended to keep your credit utilization below 30%, the lower, the better. High credit scorers tend to have credit utilization ratios below 10%.
How do credit cards work?
Unlike debit cards, which use money from your bank account, credit cards offer you a line of credit you can use for purchases, cash advances or balance transfers. In return, you must pay back the borrowed money over time.
Each month, your card issuer will send you a billing statement, and you must make at least the minimum payment by the due date to remain in good standing. Bear in mind, that if you don’t pay your balance in full each month before your due date, you’ll incur interest charges on the remaining balance month to month. As a general rule, you should only charge what you can afford to pay off each month.
How does interest work?
Credit card companies charge interest on any balance you don’t pay by the due date. When you carry a balance from month to month, the interest accrues every day based on what’s known as the daily periodic rate (DPR).
Your card issuer calculates your DPR by dividing your card’s annual percentage rate (APR) by 365 for each day of the year. So if your card has an APR of 18%, your DPR would equal 0.049%.
Remember, DPR is simply your daily interest charge that gets added to your previous day’s balance. As such, your interest is compounding on a daily basis, which is how credit card balances can grow quickly.
Although credit card interest accrues daily, the total amount of interest you owe is added to your monthly bill at the end of each billing cycle. However, you’re not on the hook to pay the interest unless you don’t pay your entire statement balance by your due date. At that point, the unpaid balance carries over to the next billing cycle, and the interest is applied to your purchases.
5 key features of a credit card
Features can vary widely from credit card to credit card, but most cards share at least these five things:
- Grace period: The period of time from the date your statement is generated until your due date, during which your credit card issuer doesn’t charge interest on purchases.
- Credit limit: The maximum amount you can charge as set by your card issuer.
- Interest rate: The price you pay for borrowing money, often stated as a yearly rate or annual percentage rate (APR).
- Fees: Many credit cards charge an annual fee to remain a cardholder. Credit card companies also charge fees for late payments, foreign transactions, balance transfers and cash advances.
- Rewards and benefits: Many credit cards offer “points” or “miles” you can redeem for cash, travel bookings or other benefits.
What are credit card points?
Points are one of the three main types of credit card rewards, together with miles and cash back. Points accumulate when you make purchases in specific categories. You can view and redeem your points for rewards through your card issuer’s online portal.
What are the different types of credit cards you can get?
Many credit card companies offer a robust portfolio of credit cards designed to appeal to the varying interests of their cardholders.
Here are some of the different types of credit cards that are available:
- Cash back credit cards: These cards are ideal if you want to earn a percentage of your spending. Cash back rewards are often easier to redeem than points or miles, but the rewards rate may be lower.
- Rewards credit cards: Some top-tier rewards cards offer generous welcome offers and extensive features like purchase and travel protections. However, many rewards cards come with annual fees and high interest rates.
- Travel credit cards: You can earn points or miles to put towards future trips, including airfare, hotel stays and other perks, depending on which travel credit card you own. Although travel credit cards offer substantial benefits, they typically charge annual fees and high APRs.
- Balance transfer credit cards: The best balance transfer cards offer a 0% introductory APR period ranging from six to 21 months. In this case, you can transfer high-interest debts to your credit card and have plenty of time to pay down the balance interest-free. Just remember, you may have to pay an upfront balance transfer fee, typically 3% to 5% of the transfer amount.
- 0% intro APR credit cards: Cards with 0% introductory APR promotions allow you to make payments without paying interest on purchases, balance transfers or both for a specified period. That means your entire payment applies strictly to your balance. However, once the introductory period expires, you’ll have to pay the regular rate – typically a high variable rate.
How to choose the right credit card
If you’re shopping for a new credit card, look for a credit card that offers the following:
- A low APR to minimize your interest charges.
- Generous rewards that align with your lifestyle, interests and financial goals.
- Reasonable or limited fees that don’t significantly offset the value of the rewards you expect to earn.
- A 0% introductory APR on balance transfers and/or purchases.
- A credit limit that’s high enough to give you some financial breathing room.
The Consumer Financial Protection Bureau (CFPB) recommends comparing multiple offers to make sure you’re getting the best rates and terms available. Once you choose a credit card you want to add to your wallet, you can submit a complete application for the card.
