How Do Credit Cards Work? 7 Things You Need to Know

Written by Elyssa Kirkham

March 21, 2017November 11, 2020Credit CardsCredit & Debt, Featured1239Elyssa Kirkham

Updated on March 21, 2017

Editorial Note: This content is not provided or commissioned by any financial institution. Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by the financial institution.

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If you’re not familiar with how credit cards work, they can be intimidating to use.

I put off getting a credit card for years because I didn’t understand them. Plus, I was afraid of getting into massive debt. In fact, a woman I once interviewed failed to understand just how do credit cards work — and racked up a $12,000 balance as a result.

But once you understand them, you see them for what they are: financial tools that you control. Credit cards can be invaluable for quickly building credit. However, if you’re not careful, it can be too easy to charge more than you can repay.

By understanding credit card basics, you will know how to responsibly spend with one — and always pay it off.

7 essential credit card Q&As

So how do credit cards work? Let’s start with the basics.

1. What is a credit card?

Credit cards – plastic cards that banks and financial institutions grant to cardholders – have information encoded in them that ties them to your credit card account. This information is used by merchants to process purchases and charge them to your credit card account.

2. What is a credit card account?

Your credit card is tied to a credit account — which is a borrowing tool and a form of debt. But unlike an installment loan, a credit card is a form of revolving credit.

This means that instead of borrowing all the money at once like you do with a loan, you borrow as you spend with a credit card. Every time you make a purchase with your credit card, you are doing it with the issuer’s money, not your own.

A credit card account will have a limit. This is the maximum amount the credit card company will let you borrow on the account.

3. What is a credit card balance?

Any transactions charged to a credit card are added to your credit card balance. This is the amount of money you’ve borrowed by charging purchases to your credit card but have yet to repay.

You add to your credit card balance every time you swipe your credit card, and you lower it every time you make a credit card payment.

However, try to limit your credit card balance to what you can repay each month in full. This is a good guideline to follow to keep your credit balance low and ensure you don’t borrow more than you can repay.

4. What is a minimum payment on a credit card?

The minimum payment is the amount you must pay each month to keep your credit card accounts in good standing. Your minimum payment will be due on your credit card due date each month.

A minimum payment is calculated based on your credit card balance. It is usually two to three percent of your credit card balance, or the outstanding interest you owe plus one percent of the balance. Most credit card issuers also have a flat amount that is the smallest they’ll charge on a credit card each month, typically $15 to $35.

The minimum payment on a credit card is small compared to your overall balance. It’s also recalculated each month. This means that the average credit card balance can take over a decade to repay with minimum payments alone — and you’ll pay hundreds in credit card interest during that time.

5. What is credit card interest?

Credit card interest, also called a credit card finance charge, is the cost you pay to have a balance. This is set by your credit card annual percentage rate (APR), which is the rate at which your balance accrues interest.

Figuring out how do credit cards work with interest can be complicated. But put simply, you will pay credit card interest on your average daily balance for the month.

You will usually have a 25-day grace period to repay a balance with your credit card issuer before it charges interest on the borrowed money. Pay off your credit card in full each month and you won’t pay credit card interest.

But if you charge, say, $100 this month and only pay $50 back, you’ll accrue interest on the remaining $50 until you repay it.

Therefore, you should always pay more than the credit card minimum to keep balances low. It will also help you avoid credit card interest and serious credit card debt.

6. What are credit card fees?

An important part of understanding how do credit cards work is to know what your credit card is costing you.

All credit card costs, APRs, and fees will be outlined in your credit card agreement that you sign when opening a credit card. Carefully read this to ensure you understand your credit card.

Different credit cards will have their own fee schedules, and some will charge more while others will charge less ― or skip some credit card fees altogether.

The main fee you should worry about is the annual credit card fee, which you are charged each year simply for the privilege of having the credit card. Depending on your credit card, you could face an annual fee of $0 up to $500. A typical credit card fee is around $50 to $60 a year and will depend on the type of credit card you have.

Credit card companies will also charge other fees on certain transactions such as:

Balance transfer fees. These are charged when you use one credit card to pay off the balance on another credit card.
Cash advance fees. These are charged when you borrow from your line of credit in cash, rather than through a purchase.
Foreign transaction fees. You pay these for purchases made outside of your domestic country.
Late payment fees. You pay these if you make your credit card payment after your monthly due date.

7. What are the different types of credit cards?

There are various types of credit cards and some work differently than others. Here are some common types of credit cards, as well as what makes them stand out:

Rewards credit cards give cardholders rewards for making purchases on their credit card. Rewards can be cash back, or points that can be redeemed for travel purchases or other goods.
Secured credit cards require a deposit of cash that is used as collateral against the credit card balance. Because they are secured by the deposit, these cards are easier to qualify for. They can be a good option for consumers who want to rebuild credit.
Charge cards require borrowers to repay their balances in full every month. So the minimum payment is always equal to the monthly charges on the charge card.
Retail cards are credit cards that are issued by a retailer or store, rather than a credit card company or bank. These credit card accounts are with the store itself.

How do credit cards work? Simply, if you’re knowledgeable

At the end of the day, credit cards can be a tricky financial tool to use. Too many credit card users make credit card choices that hurt their finances and credit simply because they don’t understand them.

If you’re new to the world of credit cards, take your time learning about them and figuring out how does a credit card work. When you understand credit cards, you will know how to get the most benefit from them. And you’ll also avoid making disastrous credit mistakes simply because you didn’t know better.

Interested in a personal loan?

Here are the top personal loan lenders of 2021!

Lender	APR Range	Loan Amount
	5.99% – 18.85%¹	$5,000 - $100,000	Visit SoFi
	6.46% – 35.99%	$1,000 - $50,000	Visit Upstart
	5.94% – 35.97%^*	$1,000 - $50,000	Visit Upgrade
	99.00% – 199.00%²	$500 - $4,000	Visit OppLoans
	5.99% – 24.99%³	$5,000 - $40,000	Visit Payoff
	7.99% – 29.99%⁴	$7,500 - $40,000	Visit FreedomPlus
	7.99% – 20.88%⁵	$5,000 - $50,000	Visit Citizens
	9.99% – 35.99%⁶	$2,000 - $36,500	Visit LendingPoint
	10.68% – 35.89%⁷	$1,000 - $40,000	Visit LendingClub
	9.95% – 35.99%⁸	$2,000 - $35,000	Visit Avant
¹ Includes AutoPay discount. Important Disclosures for SoFi. SoFi Disclosures Fixed rates from 5.99% APR to 18.85% APR (with AutoPay). SoFi rate ranges are current as of March 19, 2020 and are subject to change without notice. Not all rates and amounts available in all states. See Personal Loan eligibility details. Not all applicants qualify for the lowest rate. If approved for a loan, to qualify for the lowest rate, you must have a responsible financial history and meet other conditions. Your actual rate will be within the range of rates listed above and will depend on a variety of factors, including evaluation of your creditworthiness, years of professional experience, income and other factors. See APR examples and terms. The SoFi 0.25% AutoPay interest rate reduction requires you to agree to make monthly principal and interest payments by an automatic monthly deduction from a savings or checking account. The benefit will discontinue and be lost for periods in which you do not pay by automatic deduction from a savings or checking account. To check the rates and terms you qualify for, SoFi conducts a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, we will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull. See Consumer Licenses. Minimum Credit Score: Not all applicants who meet SoFi’s minimum credit score requirements are approved for a personal loan. In addition to meeting SoFi’s minimum eligibility criteria, applicants must also meet other credit and underwriting requirements to qualify. If you lose your job through no fault of your own, you may apply for Unemployment Protection. SoFi will suspend your monthly SoFi loan payments and provide job placement assistance during your forbearance period. Interest will continue to accrue and will be added to your principal balance at the end of each forbearance period, to the extent permitted by applicable law. Benefits are offered in three month increments, and capped at 12 months, in aggregate, over the life of the loan. To be eligible for this assistance you must provide proof that you have applied for and are eligible for unemployment compensation, and you must actively work with our Career Advisory Group to look for new employment. If the loan is co-signed the unemployment protection applies where both the borrower and cosigner lose their job and meet conditions. Terms and Conditions Apply: SOFI RESERVES THE RIGHT TO MODIFY OR DISCONTINUE PRODUCTS AND BENEFITS AT ANY TIME WITHOUT NOTICE. To qualify, a borrower must be a U.S. citizen or permanent resident in an eligible state and meet SoFi’s underwriting requirements. Not all borrowers receive the lowest rate. To qualify for the lowest rate, you must have a responsible financial history and meet other conditions. If approved, your actual rate will be within the range of rates listed above and will depend on a variety of factors, including term of loan, a responsible financial history, years of experience, income and other factors. Rates and Terms are subject to change at anytime without notice and are subject to state restrictions. SoFi refinance loans are private loans and do not have the same repayment options that the federal loan program offers such as Income Based Repayment or Income Contingent Repayment or PAYE. Licensed by the Department of Business Oversight under the California Financing Law License No. 6054612. SoFi loans are originated by SoFi Lending Corp., NMLS # 1121636. (www.nmlsconsumeraccess.org) ² Includes AutoPay discount. Important Disclosures for Opploans. Opploans Disclosures Direct Deposit required for payroll. Opploans currently operates in these states: . Approval may take longer if additional verification documents are requested. Not all loan requests are approved. Approval and loan terms vary based on credit determination and state law. Applications processed and approved before 7:30 p.m. ET Monday-Friday are typically funded the next business day. To qualify, a borrower must (i) be a U.S. citizen or permanent resident; (ii) reside in a state where OppLoans operates; (iii) have direct deposit; (iv) meet income requirements; (v) be 18 years of age (19 in Alabama); and, (vi) meet verification standards. NV Residents: The use of high-interest loans services should be used for short-term financial needs only and not as a long-term financial solution. Customers with credit difficulties should seek credit counseling before entering into any loan transaction. OppLoans performs no credit checks through the three major credit bureaus Experian, Equifax, or TransUnion. Applicants’ credit scores are provided by Clarity Services, Inc., a credit reporting agency. Based on customer service ratings on Google and Facebook. Testimonials reflect the individual’s opinion and may not be illustrative of all individual experiences with OppLoans. Check loan reviews. Rates and terms vary by state. ³ Includes AutoPay discount. Important Disclosures for Payoff. Payoff Disclosures All loans are subject to credit review and approval. Your actual rate depends upon credit score, loan amount, loan term, credit usage and history. Currently loans are not offered in: MA, MS, NE, NV, OH, and WV. ⁴ Important Disclosures for FreedomPlus. FreedomPlus Disclosures The loan terms presented are not guaranteed and APRs presented are estimates only. To obtain a loan you must submit additional information and documentation and all loans are subject to credit review and our approval process. The range of APRs is 7.99% to 29.99% and your actual APR will depend upon factors including your credit score, usage and history, the requested loan amount, the stated loan purpose, and the term of the requested loan. To qualify for a 7.99% APR loan, a borrower will need excellent credit on a loan for an amount less than $12,000.00, and with a term equal to 24 months. Adding a co-borrower with sufficient income; using at least eighty-five percent (85%) of the loan proceeds to directly pay off qualifying existing debt; or showing proof of sufficient retirement savings, could help you also qualify for the lowest rate available. All loans are made by Cross River Bank and MetaBank®, N.A., Members FDIC. ⁵ Important Disclosures for Citizens Bank. Citizens Bank Disclosures Rates and offer subject to change. All accounts, loans and services subject to individual approval. Loyalty Discount: The borrower will be eligible for a 0.25* percentage point interest rate reduction on their loan if the borrower has a qualifying account in existence with us at the time the borrower has submitted a completed application authorizing us to review their credit request for the loan. The following are qualifying accounts: any checking account, savings account, money market account, certificate of deposit, automobile loan, home equity loan, home equity line of credit, mortgage, credit card account, student loans or other personal loans owned by Citizens Bank, N.A. Please note, our checking and savings account options are only available in the following states: CT, DE, MA, MI, NH, NJ, NY, OH, PA, RI and VT. This discount will be reflected in the interest rate and Annual Percentage Rate (APR) disclosed in the Truth-In-Lending Disclosure that will be provided to the borrower once the loan is approved. Limit of one Loyalty Discount per loan, and discount will not be applied to prior loans. The Loyalty Discount will remain in effect for the life of the loan. Automatic Payment Discount: Borrowers will be eligible to receive a 0.25 percentage point interest rate reduction on their Citizens Bank Personal Loan during such time as payments are required to be made and our loan servicer is authorized to automatically deduct payments each month from any bank account the borrower designates. If our loan servicer is unable to successfully withdraw the automatic deductions from the designated account two or more times within any 12-month period, the borrower will no longer be eligible for this discount. ⁶ Important Disclosures for LendingPoint. LendingPoint Disclosures Loan approval is not guaranteed. Actual loan offers and loan amounts, terms and annual percentage rates (“APR”) may vary based upon LendingPoint’s proprietary scoring and underwriting system’s review of your credit, financial condition, other factors, and supporting documents or information you provide. Origination or other fees from 0% to 6% may apply depending upon your state of residence. Upon LendingPoint’s final underwriting approval to fund a loan, said funds are often sent via ACH the next non-holiday business day. LendingPoint makes loan offers from $2,000 to $36,500, at rates ranging from a low of 9.99% APR to a high of 35.99% APR, with terms from 24 to 48 months. The loan offer(s) shown reflect a 28 day payment cycle which is being offered as a courtesy as many of our customers are paid on a biweekly schedule and thus this may better align the loan payment dates with your actual income receipt schedule. ⁷ Important Disclosures for LendingClub. LendingClub Disclosures All loans made by WebBank, Member FDIC. Your actual rate depends upon credit score, loan amount, loan term, and credit usage and history. The APR ranges from 10.68% to 35.89%. For example, you could receive a loan of $6,000 with an interest rate of 9.56% and a 5.00% origination fee of $300 for an APR of 13.11%. In this example, you will receive $5,700 and will make 36 monthly payments of $192.37. The total amount repayable will be $6,925.32. Your APR will be determined based on your credit at time of application. The origination fee ranges from 2% to 6% (average is 4.86% as of 7/1/2019 – 9/30/2019). In Georgia, the minimum loan amount is $3,025. In Massachusetts, the minimum loan amount is $6,001 if your APR is greater than 12%. There is no down payment and there is never a prepayment penalty. Closing of your loan is contingent upon your agreement of all the required agreements and disclosures on the www.lendingclub.com website. All loans via LendingClub have a minimum repayment term of 36 months or longer. ⁸ Important Disclosures for Avant. Avant Disclosures If approved, the actual loan terms that a customer qualifies for may vary based on credit determination, state law, and other factors. Minimum loan amounts vary by state. Example: A $5,700 loan with an administration fee of 4.75% and an amount financed of $5,429.25, repayable in 36 monthly installments, would have an APR of 29.95% and monthly payments of $230.33. Based on the responses from 7,302 customers in a survey of 140,258 newly funded customers, conducted from August 1, 2018 – August 1, 2019, 95.11% of customers stated that they were either extremely satisfied or satisfied with Avant. 4/5 Customers would recommend us. Avant branded credit products are issued by WebBank, member FDIC. ^ Important Disclosures for Upgrade Bank. Upgrade Bank Disclosures Personal loans made through Upgrade feature APRs of 5.94%-35.97%. All personal loans have a 2.9% to 8% origination fee, which is deducted from the loan proceeds. Lowest rates require Autopay and paying off a portion of existing debt directly. For example, if you receive a $10,000 loan with a 36-month term and a 17.98% APR (which includes a 14.32% yearly interest rate and a 5% one-time origination fee), you would receive $9,500 in your account and would have a required monthly payment of $343.33. Over the life of the loan, your payments would total $12,359.97. The APR on your loan may be higher or lower and your loan offers may not have multiple term lengths available. Actual rate depends on credit score, credit usage history, loan term, and other factors. Late payments or subsequent charges and fees may increase the cost of your fixed rate loan. There is no fee or penalty for repaying a loan early. Accept your loan offer and your funds will be sent to your bank or designated account within one (1) business day of clearing necessary verifications. Availability of the funds is dependent on how quickly your bank processes the transaction. From the time of approval, funds should be available within four (4) business days. Funds sent directly to pay off your creditors may take up to 2 weeks to clear, depending on the creditor. Personal loans issued by Upgrade’s lending partners. Information on Upgrade’s lending partners can be found at https://www.upgrade.com/lending-partners/.