How does a credit card work?
Banks issue credit cards, which are in effect, lines of revolving credit that the credit card holder has instant access
to at millions of different locations, off line and online. A bank issues a credit card to an individual, and sets a limit
that the person can spend on the card, usually based on a variety of factors, such as how much income the person has coming
in and the person’s credit history. When the card holder reaches the limit that has been set on the card, he or she could no
longer use the card until the balance is paid down below the limit. If the card holder uses the card responsibly, the bank will
increase the credit limit periodically, assuming the card holder wants a higher credit limit.
Credit Card Bill
Once each month, the card holder will receive a bill. This credit card bill will list the transactions that the person made. The
card holder will have a choice in paying the full amount of the transactions on the bill, or to pay a smaller amount, or what is
known as a minimum monthly payment. The minimum monthly payment is typically a certain percentage of the amount charged, or a
particular dollar amount, like $50 per month. The bank makes its money by charging interest on the balance that you owe them, so
they are hoping that you don’t pay off your balance each month. The bank also makes money if you pay late, or if you go over your
set credit limit.
Building Credit
Having at least one credit card account is the ideal way to build positive credit history. This is because credit card companies
report your payment performance periodically to the major credit reporting bureaus. You can get the most benefit from your credit
cards by paying your credit card bill each month, on time. Even one late payment can cause a negative indication on your credit
file, and can also cause your credit card issuer to start charging you more interest. This is because most credit card agreements
contain a clause stating that if you are late with your payment, your interest rate will convert to the “default” rate – which is
usually greater than 20%. For this reason, make sure that your payments arrive at least a week early for processing, or better
yet – pay your bill online if your card issuer allows you to do so.
Choosing the Best Credit Card
With a sea of credit cards to choose from, choosing the right credit card offer to respond to can be difficult! Some use
smoke-and-mirrors tactics, like offering cash back or other rewards that sound nice but are hard to qualify for, or by giving
you a short period that offers an intro interest rate of zero percent, but that converts to 19.99% after six months or so.
These cards sound good but are not your best option. A great credit card offer is one that features a low interest rate for at
least the first year, and then an interest rate that is fixed at a low percent rate. Avoid variable rate interest cards, since the
interest charged on those cards is unpredictable. You also want to avoid credit cards that feature unnecessary fees, like fees for
opening the account with the card issuer, or annual fees that can run into the hundreds of dollars, just for holding the card.
Another good feature of the best credit cards is a thirty day period each month to pay for new purchases without incurring any
interest.
So there you have it! Your question “how does a credit card work” has been answered, and you know what to look for when
getting your own credit card.
Updated: January, 5 2012