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How Do Credit Cards Work?

How Do Credit Cards Work?

If you've never applied for credit before, you might rely upon your community bank or credit union. Community-based financial institutions may qualify you based upon your checking or savings account or income and not your credit history. If you have had credit challenges in the past, these smaller financial institutions are also more likely to offer products that can help you reestablish your credit. Before you apply, learn how credit cards work to maximize your benefits, find the right card, and avoid some common pitfalls.

How Credit Cards Work

Credit cards provide you with a kind of revolving credit. This means that you basically have a maximum line of credit that you can use to make purchases. If you pay off all or a portion of your balance, your credit refreshes itself. In turn, the card may charge you interest on your balance. Typically, you have a grace period of one statement cycle to pay your balance off without getting charged interest.

Some cards also have yearly fees. You might find promotional offers that waive interest and fees for a certain period of time, but you need very good credit to get the best offers.

This is a basic example of how revolving credit works:

  • You might have a $1,000 credit limit to begin with.
  • If you charge $250 and promptly pay back $50 and any interest or fees, you will still have access to $800 in credit.
  • If you pay back $250 and any interest or fees, you will refresh your credit line back to $1,000.

People mostly use credit cards to make purchases; however, many credit cards will also offer cash advances. Typically, your credit card company will set your cash advance limit lower than your maximum credit allowance for purchases, particularly before you have established a credit history. Once you have established a history of promptly paying your bills, your card company may periodically increase both your cash advance and purchase limits.

Conversely, if you miss payments, your credit card issuer may reduce your line of credit or even restrict your account. If you run into problems managing your credit, you should always proactively contact your finance company to let them know about your problem and work out a payment plan.

The company will report your good history of payment to credit bureaus, so your credit score should increase over time. You should make a habit of paying somewhat more than the minimum payment back every month to demonstrate good credit management skills. Prompt payment of at least the minimums will keep your credit scores in the good range. However, keeping your balances at no more than about half of your available credit most of the time is the best way to earn excellent credit scores.

Why Apply for a Credit Card Before You Need One? 

Do you have future plans to buy a car or home or even start a small business? For many people, credit cards provide a good way to develop credit management skills and grow credit scores. Of course, you can also benefit from your credit card by using it as a convenient way to pay for purchases and handle unexpected bills.