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How Do Credit Cards Work?

how do credit cards work

If you feel hesitant about getting a credit card, it probably stems from an unanswered question: How do credit cards work? Credit cards increase your purchasing power. When you make purchases, your available credit decreases. The lender provides a statement balance, which tells you the minimum payment and the deadline. If you do not pay the balance in full, then the company charges interest on the balance.

What Are the Benefits of a Credit Card?

Credit cards can create an avenue for debt to spiral out of control. This is made worse by higher interest rates than most other types of debt. Even so, when managed well, you can reap big rewards.

Credit

Access to more money than you have on hand is an amazing asset. It frees up opportunities and allows you to seize them without needing to wait on the next paycheck. Some credit cards even allow installments.

Rewards

Rewards can give you anything from cash to travel miles for every purchase you make. If you’re going to spend money, you might as well get paid for it.

Discounts

Some cards allow you to get special discounts on travel deals, events and rentals. If it is a store card, it might also be baked into existing rewards.

Who Could Benefit From Using Credit Cards?

Anyone over the age of 18 years old could benefit from owning a credit card. However, some people stand to get better benefits than others.

High Credit Score Owners

If you have a high credit score, credit card terms are much better for you. This, in turn, eliminates many of the risks you might otherwise encounter as a credit card user. For example, you might have cards with no annual fees, low interest rates and no late fees.

Business Owners

If you have a retail business, using your credit card to make purchases can earn you a wealth of miles, cash or other benefits. Even outside of retail, you can use your credit card to pay for business travel, utilities, small equipment and other expenses.

Young Professionals

Older people have had time to build equity and develop other types of credit they can tap into. When you are a young professional, you are only at the start of the race. Credit cards are the most easily accessible form of credit that you can use for anything.

When Should You Pay With Credit Cards?

To get the most out of your credit card, you must know when to use which one. Once you have this mastered, you can strategically maximize your rewards.

When Costs Are Within Credit Limits

Ideally, you pay for everything with your credit card and then repay the bill at the end of every month. However, at the start of your credit journey, you might not have access to very high limits. Ideally, you should keep credit utilization below 10%.

When You Get High Rewards

You might have a credit card that pays 5% cash back at restaurants, but only 1% on all other purchases. Similarly, another might pay 3% for gas and 2% on everything else. Naturally, you should use the first card for takeout and use the second card when filling up your car.

When Shopping Online

When you shop in person, the store will likely accept many forms of payment. Online, very few companies allow you to send a check. You could use your debit card, but chances are that you won’t score rewards with those.

Example of Using Credit Cards

Alex is a full-time RVer who spends a lot of her time in rural areas. Because of this, she doesn’t always have access to the things she needs. She uses her Amazon Prime card to order almost everything. When her checkout bill amounts to more than $100, she chooses the six-month payment plan, which allows her to spread out payments with no interest.

Alex earns cash back on some of her purchases, which she uses to lower her payments at checkout. She also loves to read at campgrounds, so she forfeits fast shipping and gets $1 in thanks. She can then use those accumulated digital dollars to buy eBooks for her Kindle.

Steps for Successfully Managing Your Credit Cards

Credit card bills can quickly spiral out of control, especially if you don’t read the fine print and only pay the minimum balance. Here are some steps you can take to reduce the likelihood of this happening to you:

  1. Improve your credit score before applying for a credit card.
  2. Consider applying for a secured card if you have no, new or poor credit.
  3. Research reward cards to determine which ones you might be eligible for.
  4. Track your rewards and mark your cards accordingly so you know which one to spend and when.
  5. Pay your bill in full every month, unless you have interest-free payment plans.

Quick Questions

Does credit utilization matter if I have interest-free payment plans?

The credit card company will still show the full balance owed on every billing statement, so be mindful of how much this takes away from your available credit. Otherwise, your credit score could plummet.

Are store cards good options?

Store credit cards are often known for having higher interest rates. Use store cards if you shop at one particular store often, get high rewards for it and plan to pay the bill before interest is charged.

How do I make sure I choose cards I am likely to get?

There are many personal financing apps and websites that can guide you by telling you the likely credit score to get a specific card. Some apps will even pre-approve you or match you to specific cards.

If you’re looking for your first credit card don’t forget to read our guide to the best five choices for your first credit card.

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