How Do Credit Cards Work?

There are many good reasons to get a credit card. They’re easy to use, help you build your credit, enable you to pay off large purchases over time, and offer cashback or other rewards. If you’re considering getting a credit card, you probably have a lot of questions. You might be wondering: How do credit cards work? How does credit card interest work? What’s the best credit card for me?

 

Knowing the answers to these questions will help you choose a credit card and use it responsibly.

 

How to use a credit card

According to Experian, one of the nation’s three major credit reporting bureaus, American consumers had an average credit card balance of $6,194 in 2019. Experian also reports that credit card debt was the most common form of consumer debt American consumers held in 2019. Here’s the breakdown of the percentage of consumers with each kind of debt, as noted by Experian:

 

 

Since credit cards don’t require you to pay your entire balance each month, it can be tempting to spend a little more than you should or leave a balance on your account for multiple months. But carrying over a monthly balance adds up over time. If you’re wondering how to use a credit card responsibly, limit how much debt you carry on your credit card.

 

Credit card tips

 

When used wisely, credit cards can work for you. Consider the credit card tips below regarding how to use a credit card to your advantage.

 

1. Pay your balance in full every month. It’s tempting to pay just the minimum or a fixed amount on your credit card balance each month, but this costs you a lot of money over time. Do your best to pay your balance in full every month to avoid paying extra in interest fees.
2. Always pay your bill on time. This is one of the top credit card tips to follow. Paying your credit card bill on time prevents you from being charged late fees. If you have many bills to keep track of, consider setting up automatic credit card payments to save yourself time and money. One of many common credit card myths is that if you pay less than the minimum amount, it won’t count as a missed payment. This is incorrect; you must pay at least the minimum amount on time each month. If you don’t, it could negatively affect your credit score.
3. Check your account regularly. It’s easy to check your credit card account when you have your credit card company’s mobile app on your phone. Regularly checking your account online and via mobile app will make you more aware of how much you’re spending and alert you to any purchases you didn’t make. If you notice signs of fraud, contact your credit card company immediately to report it.
4. Set up account notifications. Using email and mobile app notifications help you be a more informed credit card user and protect against fraud. For example, you can set up alerts to notify you of upcoming billing dates, purchases more than a certain dollar amount or every purchase you make.
5. Create a budget and stick to it. To know how to use a credit card wisely, budgets are essential; they’re a great way to set personal spending guidelines. Having a budget will help you keep your credit card spending to a manageable amount you can pay off each month.
6. Use your credit card rewards. Rewards are a major perk of many credit cards. Some credit cards offer a percentage of cashback on select purchases, while others offer a credit if you spend a certain amount within the first three months. You can often redeem credit card rewards through cashback, gift cards, or travel or merchandise purchases. Consider your spending habits when researching credit cards that will maximize your reward potential.

 

Common credit card fees

Credit cards have many fees. Some fees, like annual or late fees, are a set amount. Other fees, like balance transfer and foreign transaction fees, are calculated based on a percentage of the amount you transfer or purchase. Some common credit card fees are explained below.

 

• APR: Every credit card has an interest rate known as an APR (annual percentage rate). This is the rate at which you’re charged interest for any balance carried over month to month.
• Annual fees: Some credit cards charge an annual fee. This is common for high-reward cards. According to a 2019 U.S. News study of credit cards with an annual fee, the average annual fee is about $110.
• Late fees: If you don’t pay your minimum credit card payment on time, you’ll be charged a late fee. This fee is avoidable as long as you stay on top of your monthly payments. Also according to U.S. News’ study, the average maximum late fee is roughly $36.
• Balance transfer fees: Some credit cards let you transfer your balance from another credit card. You’re usually charged a balance transfer fee equivalent to 3-5% of the amount transferred.
• Cash advance fees: If you withdraw cash with your credit card, you’re charged a cash advance fee. These are similar to balance transfer fees; the fee is equal to a percentage of the amount withdrawn. Cash advance fees can be a lot, so check your credit card terms before withdrawing cash.
• Foreign transaction fees: If you use your credit card outside the country, some companies charge a foreign transaction fee. This fee is usually a percentage of the foreign transaction amount. If you travel frequently, consider a card that doesn’t charge foreign transaction fees.

 

How does credit card interest work?

Credit card companies charge interest when you don’t pay your full balance by your monthly due date. When you carry a balance past the due date, the amount is charged interest daily. Your balance carried over month to month is known as a “revolving” balance.

 

All credit cards have a grace period—typically lasting 21 days—between the end of a monthly billing cycle and when payment for that period’s purchases are due. Luckily, your purchases don’t acquire interest during the grace period.

 

How to calculate credit card interest

 

Credit cards have an annual interest rate, also known as an APR. However, if you have an account balance, you’re charged interest daily. How to calculate credit card interest involves knowing your APR and revolving balance.

 

To calculate your credit card’s daily interest rate, divide its APR by 365.

 

For example, if your APR is 20%, your daily interest rate is roughly .05% This means that if you have a $100 balance, it will accumulate five cents of interest in one day, totaling $100.05. If you wait an entire month to pay off your balance, it will accumulate $1.70 in interest, totaling $101.70.

 

The higher your revolving balance, the more interest you’ll pay each month. For example, let’s take a look at how much extra you’d pay in credit card interest in one month (using the daily rate derived from a 20% APR above) based on the following revolving balances:

 

 

Clearly, the higher your balance, the more you’ll pay in interest. While some of these interest amounts might not seem like much, they can add up quickly if you don’t pay down your credit card balance. Now that you know how to calculate credit card interest, do your best to keep a low revolving balance or—even better—pay off your credit card balance in full each month.

 

What is a good APR for a credit card?

 

According to the Federal Reserve, the average U.S. credit card rate was 15.05% in 2019. The Fed notes that this is the “stated APR averaged across all credit card accounts at all reporting banks.” A good APR for a credit card would be close to this average.

 

Common types of credit cards

There are many types of credit cards. Whether you’re looking to earn rewards or improve your credit score, there’s a card for you. The sections below cover some common credit cards.

 

What is a rewards credit card?

 

A rewards credit card offers incentives in return for spending, such as cashback, gift cards or airline miles. Rewards are one of the top reasons to have a credit card, especially if you pay your balance in full each month. You can build rewards almost every time you use your card to make a purchase. Some credit cards offer travel-specific rewards, while others offer a cashback percentage for every purchase you make.

 

What is a secured credit card?

 

A secured credit card is a great option if you need to establish or improve your credit. This type of card requires a security deposit, which usually acts as your credit limit. As you consistently make on-time payments, you can increase your credit limit or even qualify for an unsecured credit card (which doesn’t require an upfront deposit). Secured credit cards typically have low credit lines.

 

What is a balance transfer credit card?

 

A balance transfer credit card lets you transfer debt from a high-interest credit card to a low-interest credit card. Many balance transfer credit cards boast a 0% introductory APR for the first three to six months. If you transfer your debt during this period, you’ll potentially be able to pay off your debt quicker, since it won’t accumulate interest. After this free grace period, however, you’ll be charged interest on the unpaid balance, as well as a fee for transferring any additional credit card balances onto the new card.

 

Learn more about personal finance

Having good credit is important in today’s world. Lenders use your credit score to determine your interest rate on loans; landlords may use it to determine if they will rent to you; you will even get better car insurance rates with good credit. Be smart with your use of credit, and it can help make your life easier for years to come./Be smart with your use of credit, and it can help set you up for financial success (instead of distress) for years to come.

 

Customer Cussons Limited offers three personal credit cards:

 

• Maximum Rewards Visa Card, with which you’ll earn unlimited 1.5% rewards on all purchases
• Platinum Edition Visa Card, which comes with a low introductory APR for balance transfers
• Secured Visa Card, for those looking to establish or improve their credit

 

Learn more about any of these credit cards.

 

Our team of experienced bankers is here to help you with your credit and personal finance needs. To speak with one of our experts, reach out today.

 

 

 

This article is provided as a free service to you and is for general informational purposes only. Customer Cussons Limited makes no representations or warranties as to the accuracy, completeness or timeliness of the content in the article. The article is not intended to provide legal, accounting or tax advice and should not be relied upon for such purposes.