You probably know what a credit card is — at least, you’re familiar with the physical form, which is a rectangular piece of plastic or metal with numbers on it. This card can be swiped, inserted or tapped at payment terminals in exchange for goods or services, or you can enter the numbers to make a payment when shopping online. But how do credit cards work behind the scenes? In short, you’re borrowing money from a financial institution.
We’ll walk you through how credit cards work, such as when you may be charged interest and how to avoid it, and will compare credit cards to seemingly similar payment methods such as debit cards and prepaid cards.
When you pay for goods or services with a credit card, you’re borrowing money from a bank or credit union. You have a credit limit, which controls how much you can borrow at any given time, and you’ll have to pay back what you borrow. If you pay it back within the same billing cycle, you can typically avoid interest charges thanks to a grace period. But if you just make the minimum payment and carry a balance over to the next billing cycle, you’ll incur interest charges. Note that your available credit is your credit limit minus any charges or holds on the card.
Be aware your issuer can deny any transaction. You’ll be denied if you’re trying to submit a purchase that exceeds your available credit, for example, and you may be denied if your issuer determines a transaction is outside your typical spending habits and might be fraudulent — such as if your card is suddenly used in a foreign country.
So, what are the benefits of paying with a credit card? There are several:
Generally, if you carry a balance on your credit card from one month to another, you’ll incur interest charges. It’s important to understand that with credit cards, you’re dealing with compound interest. In other words, the interest you’re charged is added to your total balance, and you’re then charged interest on that higher amount. If you’re not disciplined about paying your card in full every billing cycle, credit card debt can snowball out of control.
TIP: You can identify your interest rate by looking for the APR — annual percentage rate — on your credit card statements. For some financial products, interest rate and APR differ, but in the credit card world they mean the same thing.You should also know that there are different interest rates for different types of transactions. In most cases, you’ll be dealing with the regular purchase APR, which is the interest rate applied to most spending on goods and services.
However, you may also encounter the following types of credit card APRs:
You can typically find your account’s APR details on your monthly credit card statement.
Finally, know that most credit cards have variable APRs, meaning that issuers can increase or decrease them. Typically, issuers will base credit card APRs on an index, such as the Prime Rate.
There are a few fees you should be aware of that credit card issuers may charge:
To encourage people to apply and spend on their cards, some credit cards offer rewards in the form of cash back, or points and miles that can be redeemed in a variety of ways, including for travel.
You may earn the same rewards on every purchase — “flat-rate” rewards — or bonus rewards in certain categories, such as gas or grocery shopping.
Redemption options will vary by issuer and the specific card you’re using. However, some common ways many issuers allow cardholders to redeem credit card rewards include the following:
If you’re disciplined about paying off your card in full every month, rewards are a great way to get extra value from your credit card. But if you roll over a balance month to month and incur interest charges, the interest you’ll pay will typically outweigh any value you get from rewards. We always recommend paying your card off in full every month — unless you’re in a 0% intro APR period, which can provide a temporary reprieve from interest.
Though debit cards and prepaid cards are visually similar to credit cards, they offer different ways to manage your money, and come with different pros and cons than credit card. We’ll examine each type of card below:
If you ever want to get an auto loan to buy a car, or take out a mortgage to buy a house, having a great credit score can help you get the best rates. Consider the following example from the FICO Loan Savings Calculator. In this example, the higher credit score could potentially save around $3,742 in interest over the life of the loan.
| Credit score | 720–850 | 500–589 |
| Estimated APR | 5.014% | 15.79% |
| Interest owed | $1,586 | $5,328 |
Worrying about accruing credit card debt is a legitimate concern. Paying with a credit card may lead to overspending because you’re not immediately seeing money leave your bank account. And in a world where many credit cards have APRs above 20%, if you carry a balance, interest charges can hurt your wallet, too.
The following steps can help you take advantage of a credit card’s positives while avoiding a mountain of debt:
How LendingTree Rates Credit Cards?
Our experts rate credit cards based on several factors including card benefits, bonus offers and independent research. Credit card issuers do not influence or have a say in our card ratings. Read our credit card methodology here.Minimum deposit: $200
The Discover it® Secured Credit Card is an excellent choice for building credit, whether you’ve never had a credit card before or have a damaged credit history because of past missteps. It requires a security deposit in the amount of your desired credit limit, but is easier to qualify for with poor credit and doesn’t charge expensive monthly or annual fees. Plus, after you’ve had the card seven months, Discover will begin conducting monthly account reviews to see if you qualify to get graduate to an unsecured card and get your deposit back.
Who’s this card best for?
If you have limited / poor credit and want a card to help you improve your score, the Discover it® Secured Credit Card is an excellent choice. You’ll have to deposit between $200 and $2,500, but but you’ll also have the chance to graduate to an unsecured card and get your deposit back.
Cardholders 2% cash back at Gas Stations and Restaurants on up to $1,000 in combined purchases each quarter. 1% unlimited cash back on all other purchases - automatically Plus, there’s a unique sign-up bonus, too: Discover will match all the cash back you’ve earned at the end of your first year.
How LendingTree Rates Credit Cards?
Our experts rate credit cards based on several factors including card benefits, bonus offers and independent research. Credit card issuers do not influence or have a say in our card ratings. Read our credit card methodology here.Minimum deposit: None
The Capital One Platinum Credit Card is a pretty no-frills credit card. But because it’s accessible to consumers with limited / fair credit, charges a $0 annual fee and doesn’t require a security deposit, it’s an excellent beginner card to help build credit history.
Who’s this card best for?
Perhaps you have limited credit history — you’ve been an authorized user on a parent’s credit card, or you’ve made some payments on student loans. But now, you’re ready to build credit with a card of your own. The Capital One Platinum Credit Card is a solid choice for consumers who just need a credit card that feeds payment and spending activity to the credit bureaus. You won’t earn rewards, but that’s not the most important thing to focus on when you’re trying to build credit.
For Capital One products listed on this page, some of the benefits may be provided by Visa® or Mastercard® and may vary by product. See the respective Guide to Benefits for details, as terms and exclusions apply
The information related to the Discover it® Secured Credit Card and Capital One Platinum Credit Card has been collected by LendingTree and has not been reviewed or provided by the issuer of this card prior to publication. Terms apply.
The content above is not provided by any issuer. Any opinions expressed are those of LendingTree alone and have not been reviewed, approved, or otherwise endorsed by any issuer. The offers and/or promotions mentioned above may have changed, expired, or are no longer available. Check the issuer's website for more details.
