What is a credit card? And should you own one?

A father and daughter cross a creek as he gives her a clear and simple credit card definition while learning about financial literacy. A father and daughter cross a creek as he gives her a clear and simple credit card definition while learning about financial literacy. Image:

In a Nutshell

A credit card is a tool that lets you borrow money up to a certain limit from a bank or other issuer with the understanding that you’ll pay back the borrowed amount at some point in the future.

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Credit cards can help you establish a credit history and set a firm foundation for your financial future — if they’re used wisely.

But when credit cards aren’t handled well, they can cause a lot of problems. That’s why it’s crucial to know about both the potential benefits and pitfalls of credit cards, credit scores, and how the scores and cards relate. We’ve put together this primer to help you understand how credit cards work and how you can use them as valuable financial tools to manage debt responsibly.

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What is a credit card?

A credit card is essentially a line of credit that can be used to borrow money to make purchases, transfer balances and get cash advances, with the agreement that you’ll pay back the money borrowed, plus any interest you owe on it, at a later date. To begin the process of getting a credit card, you need to apply to a bank or other credit card issuer.

When you apply for a credit card, the bank or issuer usually checks your credit to evaluate your creditworthiness, to help determine the likelihood you will repay the amount you borrowed. Your creditworthiness is judged based on different factors, including your credit history and credit scores.

The bank or issuer may deny your credit card application for many reasons, like low credit scores or no credit history. But if your application is approved, your account will be opened and you’ll be given a credit limit and interest rate.

Hard and soft credit inquiries: What they are and why they matter

Your credit limit is the maximum amount you’re allowed to charge on your card. If you have a secured card, like the Capital One® Secured Mastercard® for example, you will get an initial credit limit of $200 after you make the minimum required security deposit of $49, $99 or $200, depending on your creditworthiness. That means you may be able to spend up to $200 in purchases on the card before needing to pay down your balance (in order to continue borrowing). If you have an unsecured card, then you won’t have to make a deposit in order to use the card, and your credit limit will instead be determined by the issuer.

Your interest rate is the price you pay for borrowing money, usually expressed as an annual percentage rate, or APR.

Each month, the bank or issuer for your card will send out a statement detailing your current balance and all transactions on your account for that month, including purchases and interest charges. The statement also provides details on the minimum payment due and the due date.

If you pay the entire balance shown on your statement before the payment due date, you can avoid paying interest in most cases. This is because most credit cards come with an interest-free grace period on new purchases, typically somewhere between 21 and 25 days.

But if you pay less than the total balance, you’ll be charged interest at the agreed-upon rate on any remaining balance.

Do you need a credit card?

Not everyone needs a credit card, but they can be useful tools. Here are some questions to consider if you’re trying to figure out if you need a credit card.

Do you want to improve your credit? Having good credit is important if you want to borrow money, whether it’s for an auto loan or even a mortgage. It’s not absolutely necessary to have a credit card to build good credit, but credit cards can be a good way to demonstrate to lenders that you can use credit responsibly.
Do you have a backup plan in case of a financial emergency? In a pinch, a credit card can help you cover a surprise cost, such as car repairs or a medical cost, that you might not have enough cash to cover outright.
Do you overspend? If you’re afraid of overspending, you should carefully consider if a credit card is right for you. If you can’t pay off the full amount, also known as the balance, each month, you could end up owing extra on those purchases through interest charges.
Do you think you might pay late? If you think you might not remember to pay your credit card bill on time, it’s good to be aware of the impact this could have on your credit. One workaround is to automate your payments so that, even if you forget, you’re covered.


How to get out of credit card debt

Credit card vs. debit card

You may be able to swipe debit cards and credit cards in the same machine at the grocery store, but they’re two very different things. While a credit card extends a line of credit up to a certain limit that you agree to pay back in the future, a debit card is linked to a bank or credit union checking account and uses the money that you have in that account.

When you use a credit card, you’re borrowing money from your card issuer that you’ll pay back later. When you use a debit card, the money is taken directly out of your checking account. Debit cards might also be used to withdraw money at ATMs.

Credit vs. debit vs. cash: Which payment method do people use most?

What is a credit score and how do credit cards affect it?

Another big difference between credit cards and debit cards is their impact on your credit scores.

A credit score is a three-digit number, typically ranging from 300 to 850. Credit scores are calculated by credit bureaus, which collect information on you and your financial accounts.

Lenders use credit scores to help them evaluate how likely it is that you’ll repay your debts. FICO and VantageScore offer the most commonly used credit scoring models, though others exist. You can have many different credit scores, depending on the data each bureau has about you as well as which scoring models are used to calculate them.

Credit cards can be an important part of building good credit. Because you’re not borrowing any money when you use a debit card, using it has no effect on your credit. With credit cards, on the other hand, you are borrowing money and then paying it back. This use of credit can be reported to the bureaus. If you use credit responsibly, you could improve your credit health, or maintain your good credit.

This means that how you use your credit cards may affect your credit scores. Here are some examples of factors that make up your credit scores, and that your credit card usage could impact.

  • Credit utilization rate, or how much of your available credit you use at any one time
  • Payment history, or how often you’ve made on-time payments
  • Age of credit history, or how long you’ve had open accounts
Learn more: The factors that actually make up your credit score

Best credit cards to start out with

There isn’t a specific minimum credit score required to get a credit card. Each credit card issuer has its own criteria. But if you’ve never used credit before, Julie Pukas, head of U.S. bankcard and merchant services at TD Bank, says a good way to build a credit history is opening a credit card account.

“If your credit is low or nonexistent, you may need to apply for a secured card,” Pukas says.

Here are a few options to consider if you’re just starting out with credit cards.

Journey® Student Rewards from Capital One® Earn 1.25% cash back on purchases for months when you pay on time
Discover it® Secured Credit Card Build credit history with the three major consumer credit bureaus
Capital One® Platinum Credit Card Get access to a higher credit line after making first five monthly payments on time

Journey® Student Rewards from Capital One®

From our partner
See Details, Rates & Fees

Student credit cards are designed to help students establish good credit. The Journey® Student Rewards from Capital One® card will earn you 1% cash back on eligible purchases, which can then be bumped up to a total of 1.25% if you pay your bill on time for that month. (If you don’t, you may be charged a late fee of up to $38.) Just be aware of the 26.98% variable APR for purchases — if you don’t pay your balance off in full and on time each month, you could end up owing a lot in interest.

Discover it® Secured Credit Card

It may be helpful to think about a secured card as a sort of credit card with training wheels. You’ll put down a deposit with the bank or issuer, and the limit on your card may be the amount of the deposit or a percentage of it.

Eventually you may decide to cancel your secured card, maybe because you qualify for an unsecured card. You can get your deposit back if you cancel your secured card and pay off your balance in full or if the issuer automatically graduates you to an unsecured card.

“Once you prove you’re responsible, your deposit is refunded, and you can upgrade to a regular card,” Pukas says.

The Discover it® Secured Credit Card can help earn you cash back on eligible purchases and help build your credit, as your payment history is reported to the three major consumer credit bureaus.

Capital One® Platinum Credit Card

From our partner

Capital One® Platinum Credit Card

From cardholders in the last year

See Details, Rates & Fees

The Capital One® Platinum Credit Card is a great unsecured card for building credit, and has a $0 annual fee. You may be given a higher credit line once you’ve made your first five monthly payments on time. Watch out for the high variable APR of 26.98% on purchases, though.

Bottom line: Is a credit card worth it?

Using credit cards can help you build credit and set you up for a strong financial future. Those with excellent credit may enjoy easier access to the best rewards credit cards and lowest interest rates. But racking up more charges than you can handle or not making debt payments on time can damage your credit and cost you hundreds (or even thousands) in interest and penalties.

Credit cards can have an enormous impact on your financial goals, so consider them in the context of your budget, overall debt and other financial priorities. Use them wisely and you can save yourself from the problems that come with a rocky credit history.