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What is a credit card?
Credit cards let you borrow money from a bank under the agreement that you’ll repay it by your bill’s due date or incur interest charges.
The ability to buy now and pay later outmatches other forms of payment, such as debit cards or cash, which both require you to have the money available for payment at the time of purchase. In addition to having more flexibility with payments, credit cards help you to establish a credit score so you can qualify for other financial products, such as loans and mortgages.
There also can be some monetary perks to having a credit card, where cardholders can earn rewards on every purchase, which can be later cashed in for travel, statement credits and more. Some credit cards also offer intro interest-free periods.
And with laws like the CARD Act and Fair Credit Billing Act that help regulate the industry and provide higher levels of protection against fraudulent purchases, credit cards are more secure compared to other payment methods.
How credit cards work
Credit cards are rectangular pieces of plastic or metal that can be used to pay for new purchases by swiping, tapping or inserting your card into a card reader at checkout. Plus many cards allow you to complete balance transfers, which provide the opportunity to get out of debt.
When you open a credit card, you receive a credit limit that can range from a couple hundred to thousands of dollars. You’ll be able to spend up to that limit.
When you make a purchase with your card, it will show up as pending on your account and post within a few days. Once the transaction is posted to your account, your total balance will increase.
Expect to receive a bill from your card issuer every month that consists of all the posted purchases you made during your billing cycle. In order to keep your account in good standing, you’ll need to pay at least the minimum amount by your due date (which is the same date every month).
Thankfully most cards offer grace periods, which allow you to pay off your balance interest free for a minimum of 21 days from the end of a billing cycle. Any lingering balances after the grace period will incur interest, so we recommend that you always pay in full.
Common credit card terms
Credit cards come with dozens of terms that determine what fees you can incur from using your card. Here are the most common terms:
- Annual fee: The fee cardholders are charged every year for holding a credit card.
- Balance transfer APR: The interest rate for balance transfers, which may be equal to or greater than the purchase APR.
- Balance transfer fee: Transferring debt from one card to another may cost you 3% to 5% per transfer.
- Cash advance APR: The interest rate you incur if you take out a cash advance, which is often one of the highest APRs you can be charged.
- Cash advance fee: The fee you’re charged for each cash advance, usually 5%.
- Foreign transaction fee: Purchases made outside the U.S. may incur a fee per transaction, usually 3%.
- Late payment fee: When you pay your credit card bill late, you may incur a fee up to $40.
- Minimum payment: The smallest amount of money you have to pay each month to keep your account current. (Learn how making only minimum payments on credit card debt could cost you thousands and take over a decade to repay.)
- Penalty APR: When you pay late, card issuers may penalize you with an interest rate that’s higher than your regular APR.
- Purchase APR: The interest rate you incur for new purchases that aren’t paid in full every billing cycle.
