Credit Cards 101
November 11, 2021
There are many reasons to have a credit card, but the main benefits include convenience, protection, and the ability to build credit. Having an understanding of how credit cards work will help you choose the right cards and manage them well. Read on to learn about what credit cards are, and how they can help you when used responsibly.
What is a credit card?
A credit card allows you to access a line of credit provided by a card issuer. Every time you pay for something with a credit card, you’re borrowing money from the card issuer to cover the purchase. Then, you have to pay the money back either in full at the end of your billing cycle or over time with interest included.
How do credit cards work?
Once you are approved for a credit card, the issuer authorizes a credit limit — the maximum amount you can borrow — along with an interest rate — the amount a lender charges a cardholder on balances. This rate is calculated as a percentage of the amount borrowed. The credit limit and interest rate you receive depends on your income, other debts, credit score, and available credit you may have on other cards.
When your credit card bill arrives each month, you have three options: pay the whole balance in full, pay the minimum amount, or pay some amount in between. The most expensive option is paying only the minimum each month as it will cost you the most in interest. You will be charged interest on the remaining unpaid balance which will then be added to your next credit card bill. Paying off your balance in full is the best option because you will only pay for your purchases and avoid paying interest.
How can credit cards help your credit score?
Once you start using your credit card, the card issuer reports your payments to the three reporting credit bureaus — Equifax, Experian, and TransUnion — who prepare credit reports based on your personal credit history. This report is used to determine your credit score — a three-digit number usually ranging from 350 to 850 indicating how risky it is to lend you money. The higher your score, the more likely you are to be offered favorable loan interest rates for future purchases, such as an auto loan or mortgage.
To improve your credit score pay your bills on time, and keep your credit utilization rate — your credit card balance divided by your credit limit — under 30% for all your credit card accounts.
How are credit cards different from debit cards?
Typically, debit cards are linked to and pull funds from your checking account, while credit cards charge purchases using a line of credit. With a debit card, you're spending your own money. Using a credit card is borrowing money that you will eventually have to pay back to the card issuer, perhaps with interest.
Using your credit card responsibly is important to keep your credit score high and your credit history positive. To learn more about credit, look to your financial institution or reputable online resources for financial education. MSUFCU offers free virtual and in-person presentations on a variety of financial topics. To learn more, visit msufcu.org/events.
Tags: Learn About Credit, Credit Cards, Borrowing Money