How Do Credit Cards Work?

Credit cards work on a buy-now-pay-later basis. When you use a credit card to make a purchase, you’re borrowing money from the credit card’s issuer to complete the transaction, and then repaying the amount at the end of the billing cycle, either in part or in full. If you pay a credit card’s bill in full each month, you can essentially borrow money for free because you will be avoiding interest charges. Interest will apply if you do not pay the bill in full, and your credit score will suffer if you don’t make at least the minimum payment due.

Credit cards also work for transactions other than purchases, including balance transfers and cash advances. Balance transfers give people the chance to repay existing debt with a lower interest rate, for a fee – usually 3% to 5% of the transferred amount. Cash advances let you withdraw cash from your credit line, but a high fee and interest rate apply right away.

Key Things to Know About How Credit Cards Work

• Credit cards allow users to buy now and pay later, even over the course of months.
• Credit cards enable cardholders to build credit, unlike debit cards.
• Some credit cards reward cardholders for making purchases. Some cards charge annual membership fees.
• If cardholders don’t pay their full balance by the due date each month, interest charges are added to the balance each day.

Credit card approval depends on an applicant’s overall creditworthiness. Credit history, income and debt obligations are important factors.

How Getting a Credit Card Works

To get a credit card, you must first apply so the bank or credit union issuing the card can evaluate your credit history, income, debts and other factors to determine whether you are an eligible borrower. You can apply for most credit cards online, while phone and in-person applications are possible with many cards.

It is possible to get approved for a credit card instantly if you apply online, though it can take up to 14 business days to get a decision. After being approved for a credit card, it generally takes 7-10 business days to get the card in the mail.

Learn more about how to get a credit card.

How Building Credit with a Credit Card Works

Using a credit card responsibly is the easiest way to build credit. If you use only a portion of your card’s spending limit and pay the bill on time every month, or never make purchases with the card at all, the issuer will report positive information to the credit bureaus each month. This allows you to build a good credit score.

Plus, it’s very easy for someone with no credit or even bad credit to get a credit card, especially a secured card where your credit limit is based on how much you put down as a security deposit. The same cannot be said for loans, for example.

Learn more about how to build credit with a credit card.

How Credit Card Payments Work

Credit card payments are due monthly, roughly 21-25 days after the end of each billing period. Cardholders can choose to pay the minimum amount due, the full balance listed on their monthly statement, or another amount.

Paying at least the minimum amount due is required to keep a credit card account in good standing and avoid potential credit-score damage.

Paying the full statement balance each month is required to avoid interest, unless a card has a 0% introductory APR in effect.

Most credit cards allow payments to be made online, over the phone or through the mail. Some cards allow in-person payments at one of the issuer’s branch locations, too. The best approach to credit card payments is to set up automatic monthly payments from a linked checking account. That way, you will never miss a due date because of forgetfulness.

Learn more about how to pay credit card bills.

How Credit Card Interest Works

Credit card interest is charged daily on credit card accounts with a revolving balance – one that carries over from month to month. Credit card interest also compounds on a daily basis, which means the interest charged one day becomes part of the balance that accrues interest the next day. The combination of daily compounding and the high interest rates that credit cards are known for results in very expensive finance charges for cardholders who are not careful enough.

Fortunately, you can avoid credit card interest by paying the full balance listed on your account statement each month. This will keep your credit card’s grace period intact.

Learn more about how credit card interest works.

How Credit Card Rewards Work

Many credit cards reward cardholders with cash back, points or miles for every purchase made. Plus, the best credit cards often come with signup bonuses that cardholders can earn after meeting a minimum spending requirement in the first few months.

Credit card rewards can be redeemed for statement credits to help pay the account balance, travel expenses, gift cards and more, depending on the specific credit card. Generally, the credit cards with the best rewards go to people with high credit scores, a lot of income, and little-to-no debt. But rewards credit card offers are available to people of all credit levels.

Learn more about how credit card rewards work.

Credit Cards vs. Debit Cards

The biggest differences between credit cards and debit cards are that only credit cards enable you to build credit and borrow money. Credit card rewards are also much more abundant and lucrative than debit card rewards, and credit cards have better fraud protections.

A debit card is tied to a checking account, so the money you can spend is limited to what you have in that account. Credit card spending limits are based on the issuer’s assessment of the cardholder’s overall creditworthiness, as the issuer is lending money to the cardholder.

Learn more about the differences between credit cards and debit cards.