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What is a credit card and how does it work?

Credit cards are a popular way to make purchases, pay bills and even help manage debt in some cases. They're quite convenient and many may offer the chance to earn rewards.

Below, we'll break down the things you need to know about credit cards: what they are (and how they're different from debit cards), how they work and the different types. We'll also review why and how to get a credit card, as well as some tips for using cards to build your credit score.

What is a credit card and how does it work?

A credit card is a form of revolving credit — meaning you can borrow with it whenever you want (up to a limit) and pay it off when it's due.

Important terms to know

Here are some important credit card terms to know.

  • Annual fee: Some cards charge a fee once per year for use of the card.
  • Balance: The amount of borrowed funds on your card that you haven't paid off.
  • Credit limit: The maximum balance you can incur on your credit card.
  • Credit card network: Credit card networks authorize and process credit card transactions. They facilitate information transfer between merchants and issuers.
  • Interest/APR: Interest is the amount charged on the balance you carry, expressed as a percent. APR is interest plus applicable fees and your card can have multiple APRs (purchases, cash advances and balance transfer)
  • Issuer: The bank or financial institution that gives you your credit card. You make payments to your credit card issuer.
  • Minimum payment: The minimum amount you must pay by the statement due date for each billing period.

How credit cards work

To use a credit card, you simply swipe, insert or tap your card at the card reader when checking out. If you're paying a bill or shopping online, you'll have to enter your card number, expiration date and sometimes the three- or four-digit security code on the back of your card.

The merchant then contacts your card company to request an authorization code for the transaction. If approved, the transaction will go through and funds will transfer from the issuer to the merchant. 

Every billing period (around 28-31 days), you receive a statement containing all of your transactions for that period, your total balance and your minimum payment. You then get a grace period (usually 21 days, but varies by the card issuer) to pay at least the minimum. 

If you don't pay the full balance, your issuer charges interest based on your APR and balance. The lender adds this interest to your balance. Unless you're using a zero percent introductory APR card, making only the minimum payment may cause your interest charges to grow as a result of your unpaid balances. Paying your full balance can help you save by avoiding interest.

Your issuer reports your payment activity to the credit bureaus. Consecutive timely payments may help build your credit score over time.

The difference between credit cards and debit cards

The primary difference between credit and debit cards is that credit cards let you borrow money, whereas debit cards draw on funds you already have.

This distinction means a lot for your finances. For one, credit cards let you expand your purchasing power beyond your own funds through borrowing. With debit cards, you use the money you already have and you avoid incurring debt. This means that credit card usage may impact your credit score. Debit cards don't affect your credit because you can only use what you have available in your account.

Debit cards tend to have lower fees than credit cards, but credit cards offer much more in terms of warranties and fraud protection. If a criminal steals your debit card, they may be able to access all your checking funds — plus any savings if you've opted into overdraft protection transfers. You'll have to notify your bank within two business days of discovering the fraud to limit your liability to $50 or less. If you notify the bank after two business days, you may be liable for up to $500 in fraudulent charges.

There are ways to dispute the fraud on your debit card, but your liability depends on how fast you report the theft. If you don't discover the theft for 60 days, the bank may not reimburse you.

Federal protections are greater for purchases made with a credit card. Credit card users are responsible for no more than $50 in fraudulent charges if their card is lost or stolen. In many cases, the issuer won't hold you responsible at all.

Types of credit cards

There are several types of credit cards to choose from, each designed for different users.

Unsecured credit cards vs. secured credit cards

Unsecured credit cards don't require any cash deposits. The lender determines your credit limit based on your credit reports, gross annual income and other variables, depending on the company. Most traditional credit cards are unsecured.

Secured credit cards require a cash deposit as collateral and your limit is equal to the value of that cash deposit.

Personal credit cards vs. business credit cards

Personal credit cards are designed for everyday spending, such as gas, groceries, entertainment, car repairs and healthcare co-pays.

Business credit cards are intended for business-related purchases. For example, if you purchase office supplies for your home office or travel frequently for work, you can use your business credit card.

Business credit cards help separate your business and personal expenses.

Rewards points, travel miles and cash back cards

Cash back credit cards earn you points redeemable for cash back, a statement credit, gift cards or shopping at various retailers.

Travel credit cards earn you points or miles on every purchase that you can use towards travel and accommodations.

Some higher-tier travel credit cards offer other benefits such as annual travel credits, airport lounge access and TSA Precheck/Global Entry fee reimbursement.

Reasons to get a credit card

Credit cards can benefit you in several ways.

  • Sign-up bonuses, also known as new cardmember bonuses: Many cards pay you a one-time bonus for spending a certain amount within a period of time of opening the card.
  • Rewards: Credit cards help you earn cash back or points that can be redeemed towards travel.
  • Balance transfers for consolidating debt: A card may offer zero percent introductory APR on balance transfers for a period of time, giving you time to pay off debt interest-free.
  • Introductory purchase APRs: A card may offer zero percent introductory APR on purchases for a period of time as well, which could help you pay over time on large purchases.
  • Building your credit score: Build your credit score with a credit card and you may be able to get good rates and terms on future debt.

How to get a credit card

Here's how to get an excellent credit card for yourself:

  1. Pre-qualify: Pre-qualify for credit card offers to minimize hard inquiries while finding the best possible card for you.
  2. Fill out the application: Once you've decided on a credit card, you'll need to provide basic info about yourself and estimate your income.
  3. Authorize the hard inquiry: Give the issuer permission to take a formal look at your credit.
  4. Receive a decision: The issuer evaluates your credit and if approved will mail you your card.
  5. Activation: Your card will come with instructions on how to activate it online or by phone. This only takes a minute or two.

Tips for using a credit card wisely

Credit cards can cause damage to your finances and credit if you don't use them wisely. Follow these tips so your credit card helps improve your credit score instead of harming it.

  1. Set a budget: Avoid credit card debt by setting and sticking to a budget. Make sure your spending stays below your income.
  2. Pay your full balance on time every month: If you don't carry a balance, you won't be charged interest.
  3. Use your card for everyday purchases you'd make anyway: You have to buy things like gas and groceries, so you may as well earn rewards on those purchases.
  4. Make a large purchase with a sign-up bonus card: With select cards, you may get some cash back. Look for a card with a sign-up bonus if you're looking to make a large purchase.
  5. Monitor your score: Check your credit score regularly using Chase Credit Journey to see how you're progressing. Make sure you don't see any errors that could be harming your score, and if you do, report them promptly.
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