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How Do Credit Cards Work?

Last Updated: January 31, 2023
4 min read

Key points about: using a credit card

  1. A credit card provides a line of credit you can use to make purchases up to the limit approved by your credit issuer.

  2. You must pay a minimum monthly payment, or you can pay your balance in full each month to avoid interest charges.

  3. Some credit cards offer rewards for eligible purchases, such as cash back or miles.

Put simply, a credit card is a type of loan. A credit card issuer extends you a line of credit you can use to make purchases. In exchange, you pay at least the minimum monthly payment by the due date. If you pay your credit card balance in full and on time every month, you won’t pay interest on regular purchases.

Did you know?

Unlike a car or home loan, a line of credit from a credit card is considered an unsecured loan (a loan not backed by any collateral). As a result, standard credit card interest rates tend to be higher than secured loan rates. The bank or credit card issuer approves you for a credit card based primarily on your credit score, which can help determine how likely you are to repay the money you borrow.

Credit Cards explained

If you carry a credit card balance from month to month, you’ll get charged interest, which is where that APR, or annual percentage rate, term you’ve probably heard comes into play. While credit cards give you the flexibility to take your time paying back what you owe, you may pay for the privilege of doing so. Each month that you carry a balance, you’ll get charged interest.  Make use of Discover’s Credit Card Interest Calculator to calculate the payoff time for any credit card.

And, each month, you’ll have the option of making the minimum payment due (as determined by your credit card issuer), a larger payment, or payment in full. Making timely payments is one of the first good credit card habits you’ll want to adopt, because “payment history” makes up the largest percentage of your three-digit credit score.

As you become more comfortable using a credit card, you’ll also want to make a habit of keeping your overall utilization low. Your credit utilization rate, which is another important factor in your credit score, is the amount you owe compared to your total available credit across all your credit accounts.

How does credit card interest work?

If you do not pay your statement balance in full each month, you’ll get charged interest on purchases. If you take a cash advance or make a balance transfer, you may get charged interest from the date the transaction posts to your account, which is where that APR, or annual percentage rate, term you’ve probably heard comes into play. While credit cards give you the flexibility to take your time paying back what you owe, you may pay for the privilege of doing so. Be sure to check the terms of your cardmember agreement to learn how interest gets applied to your account. Make use of Discover’s Credit Card Interest Calculator to estimate the payoff time for any credit card.

How does your credit card usage affect your credit score?

Each month, you’ll have to pay at least the minimum payment due (as determined by your credit card issuer), a larger payment, or payment in full. Making timely payments is one of the first good credit card habits you’ll want to adopt, because “payment history” makes up the largest percentage of your three-digit credit score.

As you become more comfortable using a credit card, you’ll also want to make a habit of keeping your overall utilization low. The “credit utilization rate,” which is another important factor in your credit score, is the amount you owe compared to your total available credit across all your credit accounts.

How do credit card rewards work?

Many credit cards offer rewards like cash back rewards or miles. Generally, you earn rewards as a percentage of your purchases, such as 1, 2, or 5 percent cash back.

You can usually redeem your rewards for a statement credit, gift cards, or merchandise, as specified in your cardholder agreement. Although Discover rewards never expire1, some credit card issuers offer rewards that may expire.

Credit cards vs. debit cards

Many people have a debit card before they get their first credit card. Although they may look the same, credit cards and debit cards have some important differences in the way they work.

A credit card lets you borrow money, but a debit card is connected to an account where you’ve deposited funds. The debit card doesn’t let you borrow money, but lets you buy things without carrying cash around. When you pay with a debit card, the funds are withdrawn from your account as soon as you complete the transaction.

Credit cards may come with benefits and features that debit cards do not offer.

Choosing the credit card that works best for you

Two good options when it comes to getting your first credit card are a student credit card and a secured credit card. The secured credit card requires that you make a security deposit up front equal to the approved credit limit; otherwise, it works similarly to an unsecured credit card.

Learning how to use either a student credit card or a secured credit card responsibly can help you establish the good habits that will build your credit over time, which is an important part of learning to manage your financial life—both now and in the future.

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