Credit Cards 101: A Beginners Guide To How Credit Cards Work
credit cards are a popular and convenient form of payment that many people use on a daily basis. However, understanding how credit cards work can be confusing for beginners. In essence, when you use a credit card, you are essentially borrowing money to pay for goods and services. You are then required to repay the borrowed amount along with any applicable fees and interest charges.
The credit card industry relies on this fundamental concept, and it has become an integral part of our daily lives. It’s important to note that if you choose to pay off your balance in full each month, you can avoid paying interest charges. However, if you only make a minimum payment or carry a balance, you’ll be charged interest on the remaining amount.
In this beginner’s guide to credit cards, we will cover everything you need to know about how credit cards work. By the end of this article, you’ll have a better understanding of credit cards, how they work, and how to use them responsibly to help build your credit score.
Making A Payment With Your Credit Card: How It Works
Making a Payment with Your Credit Card: How It Works
Credit cards are a ubiquitous form of payment that is commonly used by consumers worldwide. To use your credit card for a purchase, you can either swipe it through a card reader at the register or enter your card details on an online checkout page.
Once you make the purchase, the authorization process begins. The card reader communicates with your credit card issuer to validate your card’s authenticity and ensure that you have enough credit available for the purchase amount. If the transaction meets the approval criteria, it gets authorized.
After the transaction gets approved, the merchant receives payment from the bank that issued your credit card. The issuing bank sends money to the merchant to settle the transaction amount.
Finally, you receive your credit card statement, which shows the purchase details and the amount owed to the issuing bank. To keep your account in good standing, it’s essential to repay the bank the amount charged on your credit card statement by the due date. This helps you maintain a good credit score and avoid late fees and interest charges.
The Ins and Outs of Credit Card Rewards
Credit cards have become an indispensable part of our daily lives, and the rewards they offer have made them even more popular. There are two main types of rewards that credit card companies offer:
Cash Back: You can use cash back to lower your balance, get a deposit in your bank account, or a check mailed to you.
Points or Miles: You can redeem points or miles for travel, gift cards, merchandise, or other things. In some cases, points can be redeemed for credit on your statement, just like cash back.
The rewards rate depends on the type of credit card you have. There are two main types of rewards structures:
Flat Rate: You get the same rewards rate on all purchases, irrespective of what you spend money on. For instance, you may get 1.5% cash back on all purchases or 2 points per dollar on everything.
Bonus Rewards: You earn a base rate on all spending and higher rates in specific categories. For example, you might receive 5% cash back at gas stations, or 3 points per dollar spent on travel. Bonus rewards are awarded based on where you buy something, not what you buy. Every merchant is assigned a category code, and if your card offers bonus rewards at grocery stores, you’ll earn those rewards every time you make a payment at a merchant with a category code that identifies it as a supermarket or grocery store.
Most credit card users carry multiple cards with bonus rewards in different categories and a flat-rate card for purchases that fall outside those categories.
To keep track of your rewards, they are stored in a rewards account that you can access when you log into your card account online or from the issuer’s mobile app. The rewards process works as follows:
- You make a purchase with your credit card.
2. The issuer calculates your rewards. If you have a card that earns bonus rewards, the issuer looks at the category code of the merchant where you made the purchase and applies bonus rewards as necessary. Otherwise, the issuer calculates your rewards based on the flat rate.
3. The issuer credits your rewards to your account. Depending on your issuer, it could take a few days to a few weeks for rewards to show up.
4. You redeem rewards by logging into your account online. Cash-back redemptions are straightforward, but redeeming points or miles might require booking travel through an online tool similar to Orbitz or Expedia.
Credit card rewards offer a great way to earn money or redeem points for travel or other benefits. However, it is essential to choose the right card based on your spending habits to maximize your rewards.
Understanding Credit Card Interest: A Comprehensive Guide
If you’re new to the world of credit cards, you may be wondering how credit card interest works. Essentially, when you use a credit card, you’re borrowing money from the card issuer. If you don’t pay off your balance in full by the due date, you’ll be charged interest on the remaining balance. Here’s everything you need to know about how credit card interest works:
- Credit card interest rates
The interest rate on your credit card is set by the card issuer and is based on a number of factors, including your credit score, income, and credit history. Generally, the better your credit score, the lower your interest rate will be. However, credit card interest rates are typically higher than other forms of consumer debt, such as personal loans or mortgages.
2. Daily interest charges
Credit card interest is charged on a daily basis, which means that the longer you carry a balance, the more interest you’ll pay. To calculate your daily interest rate, divide your annual interest rate by 365. For example, if your interest rate is 17.5% per year, your daily interest rate is 0.048%.
3. How interest is calculated
Credit card interest is calculated based on your daily balance. At the end of your billing cycle, your card issuer will calculate the average daily balance for the month. This is done by adding up your daily balances and dividing by the number of days in the billing cycle. Your interest charge is then calculated based on your average daily balance and your daily interest rate.
4. Minimum payments
Your credit card statement will include a minimum payment, which is the smallest amount you’re required to pay each month to avoid late fees and penalties. This amount will include your interest charge, along with any fees and a percentage of your balance. If you only make the minimum payment, it will take you much longer to pay off your balance and you’ll end up paying much more in interest over time.
5. Avoiding interest charges
The best way to avoid paying credit card interest is to pay off your balance in full each month. If you can’t do that, try to pay as much as you can each month to reduce your balance and your interest charges. Additionally, look for credit cards with low interest rates or 0% introductory offers to save money on interest charges.
Different types Of Credit Cards
Credit card providers offer various types of cards to suit different financial requirements of consumers. Some people pay off their balance in full every month and want a card that provides cashback or reward points, while others carry a balance from month to month and require a low-interest rate card. There are also cards available for people who want to improve their credit rating. Here are the different types of credit cards available:
- Rewards credit cards offer cashback, points, or miles for card usage. Different types of rewards cards include cash-back, general travel, airline, and hotel credit cards.
- Balance transfer credit cards enable users to transfer debt from high-interest cards to a new card with a 0% interest rate for a year or more, providing significant savings on interest.
- Low-interest and 0% credit cards are suitable for people who expect to have debt each month. 0% cards offer a year or more of 0% interest on purchases, whereas low-interest cards have a low ongoing rate, making them a good long-term option.
- College student credit cards are designed for students with limited credit history or income.
- Small business credit cards offer tailored rewards and perks for entrepreneurs and small business owners, including free employee cards and expense tracking tools.
- Credit cards for building credit are available for people with fair or bad credit scores or no credit history. Cards for fair credit are intended for those with scores ranging from 630-689, while cards for bad credit are for scores below 630. Secured credit cards require a cash deposit and protect the issuer against non-payment. “Alternative” credit cards assess the applicant’s income, assets, educational background, and job category instead of relying solely on credit scores.
Credit Card Rewards
When it comes to credit card rewards, there are several factors to consider before making a decision. The first is the earn rate, which is the amount you receive in rewards for each dollar you spend. Some cards offer cash back, while others give you points or miles for purchases.
Another factor to consider is the redemption value of your rewards. This refers to how much your rewards are worth when you redeem them, and can vary depending on the card and the redemption option you choose.
Redemption options are also important to consider, as some cards offer more flexibility than others. For example, some cards may only allow you to redeem rewards for statement credits or merchandise, while others may offer travel or other unique redemption options.
A sign-up bonus is another consideration when choosing a credit card. This is a one-time offer that can be a cash bonus or a batch of points or miles that you can earn by spending a certain amount within a specified timeframe. Sign-up bonuses can help offset the annual fee of a card, and some travel cards offer bonuses large enough to cover the fee for the first few years.
Perks are another benefit to consider when choosing a credit card. These are benefits that come with carrying the card, such as airport lounge access, free checked bags, and hotel room upgrades. Premium credit cards typically offer the best perks, and airline and hotel credit cards can easily pay for their annual fee with the value of the perks alone.
Other common perks include statement credits for travel expenses or purchases from selected merchants, purchase protections such as extended warranties and price protection, rental car coverage, and cell phone insurance. Some cards may also offer credit tracking and security services, such as free credit scores and credit monitoring.
When comparing credit card rewards and perks, it’s important to consider your own spending habits and priorities. Look for a card that offers rewards and perks that align with your needs and interests, and make sure to read the fine print to fully understand the terms and conditions of the card.
Credit Building Help
Credit building is a critical aspect of your financial life. Having a good credit score helps you secure loans, credit cards, and other financial products with favorable terms. However, building or rebuilding credit can be challenging, especially if you don’t know where to start. In this article, we will discuss essential features to consider when building or restoring credit.
- Reporting to Credit Bureaus When using a credit card responsibly, you want your credit score to reflect that. Therefore, ensure that your card issuer reports your payment activity to all three credit bureaus. These bureaus compile your credit reports, which are critical for determining your creditworthiness.
- Deposit Requirements If you’re getting a secured credit card, you’ll need to have money for a security deposit. Typically, minimum deposits range between $200 and $300.
- Upgrade Opportunities As your credit improves, it’s essential to be able to upgrade your account to a better card. Look for credit cards that offer upgrade opportunities to keep up with your changing credit needs.
- Incentives for Responsible Behavior Look for credit cards that offer incentives for responsible behavior, such as boosting your rewards rate if you pay on time or access to a higher credit line.
The Application Process
When applying for a credit card, the issuer evaluates the risk involved in lending you money. The application process typically involves:
- Filling out an application form that asks for personal information such as your name, address, phone number, email address, employment status, and annual income. The issuer may also ask about your assets and other obligations.
- Checking your credit report, which summarizes your credit history. This information helps the issuer determine your creditworthiness and whether to approve your application.
- Approval, which is based on the issuer’s requirements. With online applications, approvals are usually possible within minutes. If your application is rejected, expect to receive a written explanation by mail within 10 days.
- Receiving your new card within 10 business days.
- Activating your card by calling a phone number or going online.
The Easiest Credit Card to Get Approved For
Approval for a credit card is never guaranteed, even if you have an excellent credit score. However, in general, the lower the risk to the issuer, the easier it is to get approved. Secured credit cards are a recommended starting point for people working to build or mend credit. Credit cards for fair credit provide more benefits but don’t require a top-tier credit score. Store credit cards are also easier to qualify for than bank cards but have low credit limits and high-interest rates.
How Many Credit Cards Should You Have?
There is no perfect number of credit cards to have, and it depends on your needs and how much effort you want to put into managing your credit cards. While one credit card is enough to maintain a good credit score, carrying multiple cards provides advantages such as maximizing rewards, flexibility, and more available credit.
In conclusion, building credit takes time and effort. Therefore, choose credit cards that offer essential features, such as reporting to credit bureaus, deposit requirements, upgrade opportunities, and incentives for responsible behavior. Remember to manage your credit cards responsibly and avoid late payments and high credit utilization to maintain a good credit score.
