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How Do Credit Cards Work?

If you can manage them correctly and pay your balance on time, credit cards can be an excellent financial tool. They can allow you to accumulate rewards and cash back on purchases while also building positive credit history. To get the most benefit possible, it’s important to understand how a credit card works.

January 25, 2021 in Learn

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What is a credit card?

A credit card is a short-term loan from a financial institution. You can access the funds through a plastic or metal card issued in your name. It allows you to borrow up to the credit limit established by your credit card issuer. However, a credit card is not a one-time loan. You can reuse the loan continuously as long as you pay back the minimum monthly balances on time.

Credit cards versus charge cards

Credit cards give you the option to only pay back a minimum percentage or amount of what you’ve borrowed by a set due date each month. Charge cards, however, require you to pay back the full amount of what you’ve borrowed each month. Depending on your financial goals, both types of cards carry advantages.

How does credit work on a credit card?

If you’re shopping at a physical store, you can swipe, insert or tap your credit card on the merchant’s point of sale terminal. The terminal reads the security chip on the card to determine whether it’s valid to process the transaction. If you’re shopping online, you’ll have to enter your credit card number, expiration date and security code as well as your name and billing address.

 

After every approved transaction charged to your credit card, the amount of credit available to you will decrease until you pay it back again.

Understanding credit card minimum amount due

Your minimum amount due is typically a percentage or amount of what you owe on the card, but the way it’s calculated may vary from one issuer to another. The amount of your minimum amount due is how much you have to pay by a set date every month to avoid penalties. Penalties for late or missed payments on the minimum amount due could include declining new transactions, interest charges as well as damage to your credit score.

Credit card interest and fees

Credit card companies make money in three main ways: charging interest to Cardholders, charging fees to Cardholders, and billing transaction fees to merchants.

Transaction fees

Every time you use a credit card to make a purchase, the merchant is charged a transaction fee.

Credit card interest

If you only pay off the minimum amount due on your credit card balance every month, you will be charged interest fees on the amount you still owe.

Credit card fees

Some credit cards can come with an annual or monthly fee to cover the benefits it provides. Your credit card issuer could also charge you fees for:

 

● withdrawing cash

● transferring a balance from another card

● making purchases abroad in a foreign currency, or

● missing the due date for your monthly payment.

Pros and cons of a credit card

Carrying a credit card can come with major pros. They’re easier to carry and safer to use than cash. They can also allow you to earn rewards like cash back on purchases and points redeemable on merchandise. A credit card can also help you build your credit score while increasing your purchase power.

 

However, if you struggle to use your credit card responsibly, it could come with cons. It could tempt you to spend beyond your means, increase your debt levels, or damage your credit score.

How to choose a credit card

Many different types of credit cards are available, depending on your needs. For example, if you like earning rewards points, you might consider a rewards card like the American Express® CobaltTM Card, which allows Cardmembers to earn 2 points for every $1 in eligible travel purchases made on the Card.1 Or you might be interested in a cash back card like the SimplyCashTM Preferred Card from American Express.

 

Take the time to consider your purchasing history and your financial goals so you can choose a credit card that best serves your needs.

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