What is a credit card and how do they work?

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Thinking of dipping your big toe into the vast world of credit cards? Then you’ve come to the right place. get your first credit card and all those credit card payments might sound intimidating, but it really isn’t necessary.

In fact, once you know a bit more about the type of credit card you want and how you plan to use it, you’ve done most of the legwork and are ready to open a card account. credit.

Part of what you need to know about credit cards is what makes them different from debit cards and how you can use one to boost your credit score. We have all the details you need to know about obtaining and using a credit card responsibly.

What is a credit card?

A credit card is a physical plastic or metal card that can be used to make purchases, pay bills, or even withdraw cash (also called a cash advance). You can use a credit card the same way you would use a debit card, to make purchases online or in person. The main difference between credit and debit cards is that with a credit card you are borrowing money.

While debit cards work by withdrawing money that you already have in an account, your credit card takes money out of a credit linewhich you will then be required to repay at the end of each billing cycle, usually approximately every 30 days.

Having a credit card and paying it off in full each month is a great way to build credit or improve your credit score, which is something you’ll need if you’re considering applying for a larger loan, such as a car loan or a mortgage. . Credit cards are also ideal for their rewards systems, as many will award points which can then be redeemed for cash back, gift cards or even travel rewards.

Because a credit card is a form of borrowing, it can also lead to debt when misused. Credit card interest rates tend to be higher than other loans, so it’s best to only spend what you can repay each month. This ensures you get all the benefits of a credit card (better credit score, lots of rewards points), without falling into credit card debt.

How do credit cards work?

Credit cards work like small loans, allowing you to borrow against a line of credit and then gradually pay back the amounts you spend (plus interest). The higher your credit rating, the better credit card you will qualify for.

Customers with higher credit scores and a longer credit history (assuming it’s a good history) are more likely to qualify for a larger line of credit with a better rewards system. If you don’t have a substantial credit historyor if you have one that includes many missed payments or even late payments, it will be that much harder for you to get approved for a decent credit card.

Your credit card details are determined by the terms of your loan agreement. It’s an agreement made by your credit card company (which you can review before accepting a card) that dictates things like your credit limit, interest rate, how from which you will receive credit card rewardsand even your required minimum payment.

A minimum payment is the amount shown on your credit card bill that the credit card company asks you to repay at the end of each billing cycle. Minimum payments are usually calculated as a flat rate (for small credit card balances under $1,000) or as a percentage of your credit card balance plus interest rates for larger balances – but exact details of how your lender calculates minimum payments will be included in the loan agreement.

This agreement will also include details of your APR, or Annual Percentage Rate. This is basically your interest rate for the whole year, but it will also sometimes include an annual fee set by the credit card issuer.

Keep in mind that some credit cards (especially those with particularly lucrative rewards) come with annual fees, usually around $100. Other cards may offer what’s called an “introductory APR” that expires after one year. This is most often seen in cases where lenders offer a 0% APR, which then turns into an APR of 16-24% after the first year – something to note if you carry a balance on your credit card .

Credit Cards vs Debit Cards

Credit cards and debit cards work the same way: both can be used to make purchases online (or in person) as well as to set up automatic payment or to pay your bills. The main difference between the two is where the money comes from.

Whereas a debit card takes your money out of your account, a credit card draws on a line of credit – effectively borrowing that money from a bank or lender. This borrowed money can be used for purchases or for cash advances. Although you have been approved for a certain amount of credit (called a line of credit), you will need to budget accordingly so that you can make payments at the end of each billing cycle.

Since with a debit card you are using your own money, there will be no payment schedule. You can budget your expenses based on your account balance, which in some ways makes things a lot easier. You are also not required to have a certain credit score to qualify for a debit card. Because you’re just using your own money and not borrowing funds from a bank, anyone can have a debit card.

So why bother with a credit card? People get credit cards for all sorts of reasons, whether it’s to cover emergencies, to accumulate rewards points or even to build a credit score. Having a good credit rating is an important piece of the puzzle when it comes to qualifying for larger loans, like a mortgage or car loan.

How to apply for a credit card

If you’re thinking of applying for a credit card, you’ll need to follow a few steps.

The first thing to do when applying for a credit card is to check your credit score.

This can be particularly useful for knowing what type of credit card you will be entitled to. As we mentioned earlier, the better your credit score, the better card you can get (and the higher the credit limit). Since you’ll want to shop around a bit to find the best credit card possible, it helps to know your credit score and understand what this means for your eligibility.

Once you understand your credit score a little better, it’s time to start applying for credit cards. Now is also a good time to think about what you want out of a credit card. Are you looking for cash rewards, travel rewards, low APR or something else entirely? This will help you determine which cards to ask for and which to ignore.

It’s also a good idea to limit your applications, as asking for too many cards at once can actually lower your credit score. This is because most lenders conduct what is called a hard credit check (or hard draw) and having too many at once can mean to lenders that you are trying to get too much credit at once. Narrow your selection down to a few cards that you’d actually be happy to have and think you might qualify for, then you can apply for them individually on each credit card issuer’s website.

When applying for a credit card, you will need the following information:

  • Your full legal name
  • Date of Birth
  • Address
  • Social Security number
  • Annual revenue

If you are applying for a joint credit card with your spouse or if you are applying for a business credit card, you’ll likely need to provide additional information (like your spouse’s income or details about your business). Although most people apply for a credit card through the credit card issuer’s website, you can also apply by mail, phone, or in person.

Tips to improve your credit score

After learning a little more about your current credit score, you may be wondering how you can improve it further. Here are some general tips for improving your credit score.

  • Pay on time: Your credit score encompasses more than your credit card history, it also takes into account any payments you make on an existing mortgage, car loan, or even a personal loan. Make sure you pay them on time each month and it will go a long way in improving your credit score.
  • Do not max out your line of credit: Credit usage is another thing the credit bureaus consider when calculating your credit score. Credit utilization refers to how much of your available line of credit you are currently using, and lenders like to keep that number sticking. Under 30%.
  • Make a plan to settle your debt: One of the fastest ways to improve your credit score is to start aggressively. repay your debts. Make payments above the minimum and do your best to reduce those debts to zero (or at least show progress) and your credit score will likely improve as a result.

There’s a lot to learn credit card – especially if you want to use them to maximize your rewards or improve your credit score. The best thing to do is start small with a credit card you really like and make sure you can pay off your credit card balance in full each month before adding more credit cards to your repertoire. Remember, less is more when it comes to credit cards. It is always better to manage one credit card perfectly than to manage several badly.

Contributor Larissa Runkle writes frequently on finance, real estate and lifestyle topics for The Penny Hoarder.


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