Using a credit card comes with a lot of responsibility. Just one misstep can have a number of negative effects on your financial life. Missing a credit card payment, for example, can ding your credit score and result in charges, such as penalty annual percentage rates and late fees.
But credit cards can be useful financial tools if you want to build credit, earn rewards and manage your finances with consumer protections. By reviewing how credit cards work, you can use them to boost your budgeting skills and reap the benefits from big purchases and everyday spending.
What is a credit card and how does it work?
A credit card allows you to borrow against a line of credit for purchases, cash advances and sometimes even balance transfers. Credit cards are a type of revolving credit account, meaning the issuer gives you a credit limit setting the maximum amount you can borrow.
You won’t face interest charges if you can pay your balance in full and on time every month. If you can’t pay off the statement balance, you can keep your account in good standing and avoid late payment penalties by making at least the minimum payment -- typically a set percentage of the total balance -- by the due date. The remaining balance will roll over to the next month and accrue interest.
Credit card debt is one of the most expensive types of debt, as interest rates are extremely high for borrowers: The average interest rate on a credit card is currently over 20%. Credit cards charge compound interest, meaning your interest charges are added to your principal, leading to a snowball of increasing debt. You can avoid being hit with high-interest credit card debt by only charging what you can afford to pay off.
Some credit cards offer cardholder benefits, such as cash-back rewards, travel perks, purchase protections, balance transfers and 0% APR introduction periods. Some of the best rewards credit cards even offer welcome bonuses (or sign-up offers) if you spend a certain amount of money with your new card over a period of time. These perks can be rewarding, but don’t spend more just to maximize a card’s benefits.
Credit card basics
Card cards are printed with key information to identify the cardholder and safeguard personal information.
Credit card number
Your credit card number is generally a 15- or 16-digit number printed on the front or back of your credit card. It helps identify the issuing bank, cardholder and network.
Cardholder name
Along with the credit card number, the cardholder’s name is also printed on the credit card.
Expiration date
Your credit card’s expiration date provides an added layer of protection against fraud, and allows the issuer to update the card periodically. When your credit card expires, you can no longer use the physical card even though your account remains open. The issuer will usually send a replacement card before your old card expires, but you can also contact your issuer to request one.
CVV
Your credit card’s CVV, or card verification value, is a three- or four-digit number printed on your credit card to help verify that you’re the cardholder. Every credit card has a different CVV. If you lose your card, the new one you receive will have a new CVV.
Account information
Your online account and monthly statements provide important information regarding your credit card account, such as your balance, transaction history, recent activity, payment due dates, interest rate and rewards. You can opt to receive your monthly statement electronically or via mail.
Statement balance
Your statement balance includes all transactions and payments made during your most recent billing cycle. You can avoid paying interest and incurring late penalties by paying your statement balance on time and in full each month.
Current balance
The current balance on your credit card includes your statement balance plus all the purchases, interest and fees associated with your account since your last statement’s closing date, minus any payments or credits. In other words, it’s the total amount you currently owe. This number will update every time you use your credit card or make a payment.
Credit limit
A credit line or limit is what you borrow against every time you buy something with your card. Your credit limit determines the maximum amount you can charge to your card. Your issuer determines your credit limit based on various factors, like your income and credit score. You’re more likely to get a higher limit if your credit is in good shape because lenders may view you as less of a risk.
To maintain a solid credit score, try not to use more than 30% of your card’s credit limit at any given time. This is because your credit utilization ratio -- the ratio of your total debt compared to your overall available credit -- accounts for 30% of your FICO credit score. Having too high of a credit utilization ratio can lower your score.
Billing cycle
Your credit card’s billing cycle, typically between 28 and 31 days, is the period between your last statement’s closing date and the next.
Grace period
Your credit card’s grace period is the time you have to pay your bill before the balance begins accruing interest -- between the end of a billing cycle and your payment’s due date. Grace periods are typically a minimum of 21 days. If you don’t pay your statement balance by the end of the grace period, your unpaid balance will begin to accrue interest.
Cash advance
Rather than using your credit card to pay for purchases, you can get cash directly by borrowing against your credit line with a cash advance. The APR for cash advances is significantly higher than your card’s regular APR, and you might also be charged hefty cash advance fees. Cash advances typically don’t have grace periods, so interest typically accrues immediately.
Minimum payment
Your credit card’s minimum payment is the lowest amount you can pay toward your balance to avoid penalties and late fees and keep your account in good standing. Paying only the minimum means your remaining balance will accrue interest after the grace period.
Rewards rate
Rewards credit cards offer a certain amount of points, miles or cash back for every purchase you make. Different credit cards offer different reward rates, and certain transaction types or categories may also qualify for more rewards. You can typically find your rewards rate on your statement or in your credit card agreement.
Balance transfer
You can move balances from one credit card to another if the issuer allows balance transfers. It makes sense to do this when your new credit card has a significantly lower APR than your old one, such as a 0% introductory APR offer. Some of the best balance transfer credit cards offer introductory 0% APR periods for 12 to 21 months.
Balance transfer offers can help you tackle debt, but you’ll need a plan to fully pay off the balance before the introductory APR period ends. Otherwise, your remaining balance will begin accruing interest at the card’s regular APR. (See below.)
Balance transfer fees
If you use a balance transfer credit card, you’re typically charged a fee to transfer a balance. Most issuers charge between 3% and 5% of the total amount you transfer, though most have a minimum fee (usually $5 or $10). Credit cards without balance transfer fees are rare but do exist, though they tend to offer shorter introductory APR periods.
Costs of carrying a credit card
Whether you’re paying a high annual fee or carrying a balance on a credit card, credit cards can be quite expensive if you aren’t careful. However, most fees are avoidable if you know how to dodge them.
APR
Your card’s annual percentage rate, or APR, is the interest rate you pay when you carry a balance on your credit card. Credit card APRs are typically variable, meaning they can fluctuate based on the prime rate. You can avoid interest entirely by paying your balance on time and in full every month.
Foreign transaction fees
Some credit cards charge foreign transaction fees on purchases made outside the US or in a foreign currency. Foreign transaction fees typically range from 2% to 5% of the total transaction amount, though 3% is pretty standard. If you travel frequently, you can avoid such fees by using a card with no foreign transaction fees.
Annual fees
Some credit cards charge a lump sum annual fee to remain a cardholder, ranging anywhere from less than $100 to more than $600 a year. An annual fee may be the right option if the card’s rewards or perks outweigh the cost of the annual fee. But annual fees aren’t always worth the high price if you can’t take advantage of your card’s benefits.
Late payment fees
You’ll get hit with a late payment fee from your issuer if you don’t pay at least the minimum amount by your credit card’s billing due date. Late payment fees vary by issuer but can be as high as $41. You can find information about the late payment fee for your credit card in your cardholder agreement.
The bottom line
A credit card can be a valuable tool for building credit and earning rewards, but it can cause quite a bit of financial distress when used without caution. It’s important to understand how credit cards work so you can effectively manage your balance each month.
Correction: An earlier version of this article was assisted by an AI engine and it mischaracterized some aspects of credit cards. Those points were all corrected. This version has been substantially updated by a staff writer.
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