Credit cards explained

An overview on credit cards

A credit card is a form of revolving credit, which means you can borrow as many times you want against the card limit, and repay it from time to time. An issuer gives you the card, and rather than receiving the full amount in cash like it is for a personal loan, you spend a portion of the credit, and once you have paid it back, that amount is again available.

Credit cards are held by millions of Americans because they can finance short-term expenses such as small regular purchases or emergencies, and are a safe way to carry money, in fact, they offer protection from theft and on transactions, as opposed to using cash; additional exclusive perks are available, depending on the several types of cards, that you won’t get with the more traditional loans. According to the last biennial Report of the CFPB Consumer Credit Card Market, in the U.S. there are roughly 480 million credit card accounts, which are more than the entire States population: this is because the average adult tends to hold multiple cards, and clearly for reasons.

If used responsibly, they are a worthwhile financial instrument that will come to your advantage, especially in the long run; likewise, if you can’t manage well your repayments, you would create debt.

How do credit cards work?

A credit card is a financial product issued by a bank, company, or retailer, aimed to give you money quickly available for purchases, or to withdraw for cash, borrowable up to a limit that varies according to the card of choice and your status as a prospective holder. It is normally about an unsecured loan, meaning that you don’t use an asset of yours as collateral for the potential inability to pay off the debt; that is also why interest rates on credit cards are particularly high, so you need to have some discipline both with spending and repaying.

Whenever you borrow from a credit card, your credit scales down of that amount and that is your balance: let’s suppose you have a card with a maximum limit of $10,000, and use $500 to go shopping: you enter into a billing cycle, at the end of which you will have a term (due date) to pay off that amount, either fully or partially by a minimum. If you can make the repayment within the overall term, there won’t be interest, otherwise, you will be charged according to the APR set on the card by the issuer.

So, as for every kind of loan, there will be of course the repayment phase, but the difference lies in that you won’t have to pay interest if you can extinguish the debt within a window “grace period” that is usually 21 days, up to 25. In other words, credit cards basically charge interest on every gap towards the credit, if there are late payments toward the term, and rates are typically higher compared to other loan types.

After each purchase, you have what is called the balance, which is best paid off entirely on a roughly monthly basis; alternatively, you could make just a minimum payment, which is calculated by your card issuer typically as a percentage of the balance. Unlike loans, credit cards are a form of borrowing without a pre-fixed term other than the billing cycle applied to each used portion of the credit.

The main advantage of a credit card is flexibility: you can borrow multiple times until the credit is exhausted, as long as you repay in a timely manner, according to terms conditions set by your issuer. While making minimum repayments is comfortable in the short term, doing so consistently will create a crescent pending debt, also carrying interests on it. Paying on-time and in full amount should be the rule: failing to do so, you will accumulate debt, and your credit history will be negatively impacted. Your credit score will reflect that and you will get disadvantaged for getting more important loans, like a mortgage, a student or business loan, or for buying a car.

Credit limits are determined by the card type in itself, the issuer, and will also be weighed on your credit score. Under some circumstances, it is possible to borrow more than the maximum limit on a card, but that should be avoided since it is an option that will reveal expensive: it will impose a “credit limit fee”, as well as higher interests.

Similar to credit cards are debit cards, but only in the way they are charged with some amount of money that can be used for making payments, for instance, online purchases: in this case, you also make the deposit, which is usually a portion of your checking account, and what you use won’t have to be given back, since there are no interests.

Mind also that credit card networks are different from issuers: networks are meant to process transactions between cardholders and merchants, and charge a fee on the latter for each operation, but has no control over interest rates and fees which are due by holders. Some popular networks like Visa and Mastercard are strictly such, while others like American Express and Discover function both as networks and issuers.

Most credit cards charge some service fees, among which the main are: annual fees, fees for late payments, balance transfers, foreign transactions, and cash advance fees when you withdraw liquid cash from your credit, which can be an option allowed, although a costly one. All of these should be taken into account to an extent when making your card choice.

What if you can’t repay credit cards anymore?

If you can’t make at least the minimum payment before the “statement due date”, you will be subject to a late penalty fee, which is a kind of interest. When you are unable to pay off the debts accumulated with one or, more likely, multiple credit cards anymore, you may have several options including debt consolidation, using a personal loan, payment deferral, and possibly other debt-relief steps. If all of those failed, and typically 90 days (of non-payments) passed since the mentioned due date, you will be subject to the closing of the credit card account, and legal consequences such as a lien on your bank account, and in some States you can be sued, resulting exclusively in economic damage. We recommend resorting to the National Foundation for Credit Counseling (NFCC) for preventing such extreme contingencies.

Credit cards terminology

– APR: annual percentage rate. Since it is applied to your monthly payments, the value is divided by 12: if you repay fully toward your credit within the billing cycle, it won’t be calculated at all, but this is difficult for more than half of American cardholders, according to Federal Reserve. APR is not necessarily the same as the interest rate: in some cases, it is comprised of interest plus eventual annual fees, depending on conditions set by issuers.

Different types of card accounts will have differing declared APRs, depending on market indexes and companies’ individual factors. Issuers can allow a fixed or, in most cases, variable APR; even when you choose a fixed rate, they have anyway the right to raise it, based on the general economic fluctuations. Some credit cards have the short-term convenience of a zero introductory APR as an incentive for prospective holders, but will be charged with a higher than standard APR later.

The actual APR you get will lastly depend on your income and credit score because these are the most relevant factor determining if and to what extent you will be able to repay the loan: a higher risk for lenders will translate into a greater APR.

– Balance: what you owe toward your credit limit in a given time. If you can’t repay fully what you borrow, you carry a balance that accumulates over the months and is subject to accruing interests.

– Balance transfers: moving the balance from a credit card to another with a more advantageous APR, such as a zero introductory rate, usually done for debt consolidation. This is especially true for multiple cards holders who carry several interests from those, needing a period of debt relief or just more convenience. Transferring credit might come with a fee, which is 3-5% of the total amount involved, but up to 8% in some circumstances; however, credit unions and some banks don’t charge it.

– Billing cycle: the period between the bill statements, during which you have used part of your credit limit. It usually lasts 28-32 days, after which you have to make the repayments, within a 21-25 days window.

– Cash advances: whenever you withdraw money from a credit card, those are called cash advances. This operation is generally costly, in fact, it has a standalone APR which is higher and applies directly: interests on cash advances start as soon as they are made; besides, you might be charged with a surplus fee. This is an option mainly reserved for facing emergency expenses.

– Minimum payment: the portion of the balance that is at least required to be paid off roughly every month, for not incurring in interest, which would come in the form of a “late payment fee”. It is calculated either as a flat dollar amount or, most of the time, as a percentage of the new balance (possibly including accrued interest).

– Statement due date: the precise term within which you have to give back what you owe, making at least the minimum payment, in order to avoid accruing interests.

  • Overall convenience and safety. Credit cards are essentially intended as an alternative to cold cash, allow ing a more practical way to carry it, while constituting security means against theft: if a card is stolen, the robber will be impeded to make transactions, because of the PIN block; if he can make through it, any operation can still be stopped by the issuer, and you have the right to be reimbursed since you weren’t responsible for the use of credit. If you misplaced the card, you would still have greater protection than if losing bucks. The issuer becomes liable for fraudulent transactions, this is also true when buying from a dishonest merchant who takes the money but not returns the goods. Generally, there is some degree of purchase security with most credit cards, such as refunding or waiving the cardholder’s liability for defective, damaged, or lost products. Claims for such occurrences may have limits of $500, $1000, or $10,000 each, depending on networks/issuers, with an absolute cap of $50,000 per cardholder, or up the same amount applied annually.
  • Discounts. An incentive for buying with credit cards is that many of them can offer discounts on transactions (cashback), that are generally in the range of 1-5%. You may use discounts at your advantage for regular expenses like bills, food, etc., which will make you potentially save a few bucks dollars a year, provided that interests and fees don’t exceed the rewards.
  • Benefits. The plethora of credit cards available come generally with some perks that differ mainly depending on their type and issuer. If you pay an annual fee on a credit card, it is likely that it offers more benefits than a card with no fee: for instance, you might get travel insurance for lost/stolen luggage or flight cancellation/ticket disuse that couldn’t be otherwise recouped (if using the card for paying the trip); or, car insurance in the form of roadside assistance for emergencies, or even coverage for accidents of a rented car.
  • Credit score building and possible improvement. Diligently paying off your card balances will go into your credit history, and demonstrates to future lenders that you are able to manage debts. Holding a card and making small, regular, and on-time payments is an effective way to build your credit. If you already have a good income, the responsibility to carry a debt along with payments consistency is going to improve your credit rating over time, putting you in a better position to get lower interests also from other types of loans: this will result in an overall saving.
  • Higher APRs than other forms of loans. Since credit cards are a kind of unsecured loan and while they allow a grace period of no interest, you will be paying relatively high APRs, for compensating the issuer’s related risk of lending at such conditions.
  • Lower limits. Despite the comfort of borrowing and repaying multiple times, you have a reduced amount at your disposal in comparison to any other loan modality. In fact, you will have a cap set at around $10,000 even with the best credit score, and gradually inferior limits for lower ratings. This comes with a purpose: with credit cards, you are meant to make small frequent purchases, instead of taking a big lump sum for a major necessity; in this last case, a personal loan is more suitable.
  • Possible debt perpetuation: the structure of repayments can be, for some people, an incentive to impulsive buying without considering the affordability in the long run. Since you are not forced to give back the full amount borrowed, you may be tempted to make just the minimum payment consistently, or any way to defer the pay-off, underestimating the extent of debt accumulation. This is more likely to happen when using multiple cards: if you have pending debts from more of them, you might be in the position to seek consolidation in a unique card that aggregates all their APRs in a more convenient one. However, this eventuality should be avoided in the first place.

Types of credit cards

Designed to the buyers’ specific needings, there are several card types you may choose from. If you, for instance, are generally a careful unpretentious buyer, your best option could be a card without annual fees, which gives you discounts in the form of cashback. If instead, you are more assiduous your way to go is a card with those fees, that will offer a range of benefits in return.

Regardless of the card, the payoff modalities will be nearly the same, and the right timing is fundamental for not incurring into interests; it is quite common for an American to have more cards, but it will require diligence to manage them.

  • Cash back. This is a quite standard credit card, which offers a return as cash on all purchases, with percentages that vary depending on categories of goods: either said, you get a discount that could be in a range of 1-3%, even up to 5% for some products or services. You will redeem several tens of dollars in the form of direct deposit on your bank account, checks, or gift cards.
  • Prepaid. They are more like debit cards in the way that you, instead of the issuer, load money on them and that’s your credit, that you can also withdraw later: you are not borrowing, so you are not required to pay off your own credit, that can’t be exceeded. A prepaid card is not tied to a bank account, like a debit one is. You can usually get a prepaid card for a small monthly fee (and charged with others), or it can be a form of reward from retailers or companies for their customers, meant to be used exclusively with them
  • Rewards. Most credit cards are of such kind, which means they offer bounties for making frequent expenses by their use: you earn points that can be redeemed in the form of flight discounts, hotel accommodation, restaurant coupons, and several others; in some cases, you can also receive cash back. These types of cards usually have annual fees or the higher APRs, so a prospective holder must weigh the convenience of getting the perks against the overall cost: rewards cards are not ideally geared to sporadic buyers, and require some eligibility criteria.
  • Charge. A charge credit card has a way higher limit than any other, commensurate with a holder’s affordability, and some cards can have virtually no one at all: the difference is that you can only pay off the balance fully at the end of the month. If you can’t repay, you will be charged with a strong late payment fee, while you neither can’t carry forward a balance nor there is interest (no APR). You must generally have a more than a good credit score to be eligible for a charge card; it comes also with relatively high annual fees.
  • Secured. These cards are an option if you have less than a fair credit score or no credit: securing your loan means you will make a cash deposit, usually starting at $200, that will function both as your credit limit and as the collateral amount your issuer can take if you won’t be able to pay off what you borrow. Secured cards are meant to obtain credit with rates otherwise not feasible for your financial status. As you improve it, you can close the secured card account and get back your deposit.
  • Business. If you are the owner of a business, these cards are tailored to finance the related expenses, with the advantage of holding them on a separate account: with business cards, you have specific perks such as cash back on equipment, discounts for services, as well as medical and travel assistance, to mention some.
  • Store: retailers can give their own store credit cards to loyal customers who frequently shop with them. These cards can only be used for the shop goods, and have generally low credit requirements, while they will have substantial annual fees that compensate for the issuer’s risk. If discounts are enough meaty, then holding a store card is a convenient choice.
  • Balance transfer: these cards are used to move the balance from other credit cards, usually with high APRs, in order to consolidate the holder’s debt under a new unique lower interest. Some of these types of cards offer a zero introductory rate for a duration in the range of 12-21 months (possibly up to 24), which represents a comfortable debt relief window. Within that period, you can pay off your balance without the interests of the previous cards.
  • Student. These are tailored for the student’s financial condition (little or no credit), and ideal for building credit: they have average or zero APR to start with, but can offer a bunch of rewards and benefits.

What is a good credit card APR?

Credit card APRs vary widely depending on issuer and type of card: average is roughly at 17%, according to the most recent report of Federal Reserve, which is quite high compared to other kinds of loans. Generally, you may expect a range of 13%-22%, embracing all the credit scores, although an APR can drop to 8% or go beyond 25%; a good APR can be considered anything below the national average, and will definitely be based on your credit rating.

Even with poor scores, or when just beginning to build credit, there are dedicated cards that can satisfy the needs of every borrower. Bad scores resulting from a long history of late or missed payments are the only situation where you are likely to be denied on the application for credit cards.

How do credit cards affect credit score?

If you are planning to use credit cards, or you are currently doing it, you have to know that diligent use of this financial product is critical for your credit profile and its score, as mentioned. Your best move is to make punctual payments, most of the time, and those should be made in full rather than fractioned: it will demonstrate responsibility, and the ability to manage your earned money. With a credit card, you can improve a previous poor or somewhat less than optimal financial condition: this could be achieved, for instance, through debt consolidation with a successful payoff.

On the other hand, reckless behavior can ruin your credit, since any activity with your card will be recorded from credit bureaus into reports that last seven years. That puts you in a disadvantageous position for obtaining loans like a mortgage or personal loans of a certain size, at least as for getting convenient rates, at worst for a matter of qualification.

“Credit utilization ratio” is key: this is a relevant parameter used to determine a credit score, and refers to what portion of the available credit limit you are carrying as a balance, in other words, how much credit you are using. The least it is, the better. It is generally recommended to have a ratio consistently below 20% while carrying a balance greater than 30% of credit limit is certainly going to penalize your credit score.

When to use credit cards?

Small frequent loans obtained through credit cards are purposely taken to finance purchases and little emergency expenses when there is no available cash in the short term. While with conventional loans you are given a set term that is of years, with credit cards you are responsible to make the repayments as soon as possible, for not incurring in the interests: this should be the main point to consider.

One of the key advantages of borrowing through credit cards is right that they won’t impose interests if you can manage to do the repayments on time: if you are about commitment in the short term, then credit cards are for you. If, instead, you need to be financed for any reason, but more time to repay the debt, then they should be avoided, and a personal loan would be your best bet.

If you are eligible for a 0% APR credit card, that is a deal you won’t find otherwise from loans, that should be considered if you have an instant need of money for life issues and affordable time to repay the debt.

Another good point to use a credit card is to benefit from rewards, so that when you are taking money to do shopping, for groceries, or even less than basic needs, you get something in return, not just a mere borrowing and repaying with the interests.

If you are a shopper, you can obtain several perks that are intended to make you save in the long run, but it will be still up to you to make calculations, and see if what you leave on the table for the card fees is actually worth the benefits, or instead, it is the contrary. If you use to make online purchases, getting a quality brand card will give you a range of protection against several kinds of possible illicit activities.

Which credit cards to choose from?

According to a 2019 survey (source:, two-thirds of Americans select their cards mainly because they just don’t have a reward card, and another roughly 13% look at rates of earning rewards: doing the math, roughly 80% basically wants to receive some kind of benefit while making their purchases.

When you are in the process of selecting the right card, you should first consider if you can actually qualify for it. Usually, you would directly apply on the card issuer website (or at a bank), and after providing some personal details, you get either approved or are denied: however, this is a kind of hassle for most people and it will involve a “hard inquiry” on your credit history, which impacts negatively on the credit score for a short period.

Instead, online issuers provide the option of going through pre-approval, or pre-qualification (they mean the same thing in this context) for multiple cards: this means they will do a “soft credit check”, after which you are given feedback stating if you are likely to qualify for their product. Your income and history of payments will be preliminarily seen by an issuer, to determine which rates you should be charged; many credit cards will allow this step, in fact, they will come as pre-approved cards.

When you see the advertised conditions of each credit card, APRs are specified as public offers in a percentage range, or as single values; with pre-approval, you will get a private offer that is tailored to your financial status, so your APR will be different and possibly better than the one you saw in the first place. Besides, some issuers are more transparent than others about specifying that they are offering pre-approved/qualified cards, while for others you may have to read more between the lines.

Other parameters to look at are: “purchase APR”, if there is an intro APR, rewards, a signup bonus, balance transfer availability, annual fees; credit limit is generally not visible before applying. Mind that there is also a specific, separate APR for operations such as cash advance or balance transfer. Well-performing customer service is also important, since you may want to be readily assisted if there were issues of any sort: an overall high rating from a large number of reviews is certainly a good rule of thumb to guide your choice.