Credit Karma Guide to Credit Cards
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Welcome to credit card 101. Here, you’ll learn all the credit card basics: what they are, how to use them, the different types of cards and common mistakes cardholders should avoid. With this knowledge, you’ll be able to make an informed decision about which card is best for you and how to use it like a pro.
You may have a relative or friend who’ll quickly share an opinion on the dangers, or benefits, of using credit cards. But really, they’re just a financial tool.
A credit card can help you build credit, securely shop online or in stores, and serve as an emergency backstop during financial emergencies. You may have also heard that credit cards can lead to overconsumption and high-interest debt. That may be true, but don’t let that intimidate you. As with most financial tools, both the risks and rewards with credit cards come from how you use them and the financial habits you instill in yourself.
Believe it or not, the dangers of credit cards are avoidable. You just want to make sure you know your stuff before you dive in. That includes all the basics about how credit cards work, the types of cards you can get and the common mistakes you want to avoid.
That may sound like a lot to learn, but don’t worry — we’ve got you covered. In this guide, we’ve compiled all this information and more so you can start on the right foot with credit cards and start using them like a pro in no time.
What’s a credit card?
Credit and debit cards may look similar, but they work differently. With a debit card, when you make a purchase, the money comes right out of your checking account.
With a credit card, when you make a purchase, you’re borrowing money with a promise to repay it later. If you don’t repay the loan in full, you’ll have to start paying interest on the money you borrow.
As you use a credit card to make purchases at stores and online, the money you spend gets added to your card’s balance. Your card’s credit limit could determine how high your balance can be at any given time, so you’ll want to pay attention to how much you’re charging to your card. Get too close to your credit limit, and that could spell bad news for your credit scores.
You get a bill each month for all the charges
At the end of your billing cycle or statement period (which is usually about a month long), you’ll receive a statement that shows your current balance, the amount due and when your payment is due.
Most credit cards give you a grace period on purchases. The grace period, which is usually at least 21 days long, is the time between the end of your billing cycle and your bill’s due date.
As long as you pay your bill in full before the due date, you won’t have to pay any interest on the balance or on the purchases you’ve made since receiving your statement.
What does this look like in real life?
Let’s say you get a new card and make a $100 purchase with it on March 1, the billing cycle closes on March 24, and your payment due date is April 21. The time between March 24 and April 21 would be your grace period, during which you can pay off your $100 balance without paying any interest. (The length of the grace periods vary from card to card, so you’ll want to make sure you pay attention to your individual due date.)
If you pay off your balances in full each month, that means you’ll keep your grace period from one billing cycle to the next — which means no interest charges for you.
You can revolve a balance, but it’ll cost you
If you do carry, or revolve, a balance — meaning you don’t pay off your balance in full by your due date — you’ll have to pay interest on the amount you revolve and your new purchases will start to accrue interest immediately (you won’t be within your grace period anymore).
Know your interest rates
Interest rates can vary depending on the credit card and your credit health, and they’re often displayed as an annual percentage rate, or APR.
The APR is simply the interest rate, inclusive of compounding and fees, which gives you a more accurate representation of the cost of carrying a balance than just the interest rate alone.
Some credit cards have an APR range, and the APR you receive is correlated with your credit scores. In October 2017, Credit Karma members with bad credit had an average APR of 19.16%, while those with excellent credit had an average APR of 15.67%.
How is interest calculated on credit cards?
When you carry over a balance, your credit card company will begin charging you interest. Your card’s annual percentage rate, or APR, tells you what your interest rate is over the period of a year, but credit card companies also use your APR to calculate interest on your charges over your monthly statement periods.
You can also use your APR to calculate how much interest you’re paying on your balance per day. To get this number, you can divide your APR by 365 or 360 (check your card’s terms to see which).
Credit card issuers either multiply your daily rate by your balance at the end of each day, and then add the interest to your balance, or multiply your daily rate by your average daily balance throughout your billing cycle.
Some cards’ interest rates also may increase or decrease over time if they’re tied to a “market rate.” And if you miss a payment, a higher penalty rate may apply to future balances (or even your current balance if you miss two payments).
Always make at least minimum payments on time
Sometimes you might not be able afford to pay the entire bill. Perhaps you went over your budget or you had to pay for an emergency expense that will take time to pay off. When this happens, you can pay part of your balance and revolve the remainder.
Your statement will show your minimum payment amount, which is the amount you need to pay by the due date to avoid late charges. Late payments can also hurt your credit, so it’s important to always make at least minimum payments on time.
Your minimum monthly payment could be a percentage of your balance (such as 1%) or a flat fee (such as $30), whichever is greater. Additionally, you may need to pay fees, interest charges and any amounts that you’ve spent above your credit limit. But even if you have a low minimum payment, it’s best to pay more than the minimum if you can afford it.
For example, if you have a $1,500 balance at a 16% annual percentage rate and you stop using the card for purchases and only make a $30 minimum monthly payment, it could take you 83 months to pay off the balance. You’ll also pay $988 in interest. But if you pay $100 a month, you’ll pay off the balance in 17 months and pay $185 in interest.
Should you open a credit card?
The average American has 2.69 credit cards, according to TransUnion® data from the first quarter of 2017. And Credit Karma members tend to have a few more cards. But you shouldn’t feel pressured to follow the trend if it doesn’t suit you.
Credit cards can have high APRs and fees, and using a card could wind up costing you a lot of money if you can’t afford to pay the bill in full and on time. If you’re prone to spending more than you can afford to repay each month, you might want to hold off getting a credit card for now.
On the other hand, credit cards can be helpful and rewarding financial tools.
Some people have two cards — one for everyday expenses and another for monthly bills — and create systems that let them easily track their spending or notice if their bills increase.
Others keep just one credit card open and use it only for emergencies or traveling, because it can be easier to rent a car or stay at a hotel with a credit card than a debit card.
Then there are those who have multiple rewards cards and switch the card they use depending on how many rewards points or miles they’ll earn on certain purchases.
Whatever your reason, each time you apply for a credit card, the issuer will review your credit reports and scores, income and monthly expenses. The card issuer can use this information to determine …
- Whether it will approve your application
- Your APR
- Your credit limit
Other aspects of a credit card, such as the rewards program, fees and benefits, may be the same for every person who applies. Credit card companies create credit cards with specific features to attract consumers, and you can choose among different types of credit cards to find one that best fits your lifestyle.
Does using a credit card have to cost me money?
Nope. Although some people struggle with credit card debt, others earn hundreds — and sometimes thousands — of dollars in rewards each year without paying the credit card company anything.
Roger Ma of lifelaidout.com says if you open a card without an annual fee, and avoid purchase- or payment-related fees, “as long as you pay your balance in full and on time each month, then using the card won’t cost you any money at all.”
Credit cards can also be a safer option than debit cards when shopping online or in a store. Many American Express, Discover, Mastercard and Visa cards come with zero-liability protection.
If there’s an unauthorized purchase on your card, whether it’s due to your information being compromised or a retailer double-charging you, the issuer usually won’t hold you liable for those charges.
There may be some stipulations, though, such as credit card companies requiring you to promptly report losing your card and to take reasonable care to protect it from theft.
Types of credit cards
Let’s go over a few common types of credit cards. You may have heard of some, and some others may be brand new to you. Either way, understanding all your options and which cards can help with certain needs will help you make better decisions when picking out a card.
Secured credit cards can be a good option if you’re new to credit or had credit trouble in the past. When you open a secured card, you give the issuer a refundable security deposit that it can use to pay your bill if you don’t repay your balance for an extended period.
Retail credit cards — or store cards, as you might know them — are co-branded credit cards such as a Macy’s or Best Buy card. They’re often offered in stores with a discount, coupon or financing deal, or you might see them advertised on the retailer’s website. Retail cards may be easier to qualify for than other types of credit cards, but they also may have lower credit limits and higher interest rates. And sometimes you can only use the card at the associated retailer.
Rewards credit cards give you rewards when you use the card to make a purchase. These credit cards are part of an incentive program “designed to help credit card companies attract new cardholders and encourage the use of their credit cards,” says Ma of lifelaidout.com.
“Rewards vary depending on the particular credit card, but some include cash back, airline miles or hotel points,” he says. Depending on the program, you can redeem your rewards for a variety of things, including travel, merchandise, statement credits or a check.
In addition to different types of programs, there are different types of rewards cards, including ones that give you the same reward no matter where you shop and others that offer bonus rewards when you make purchases at specific types of retailers. If you’re looking for a rewards card, try to find one that offers bonus rewards at places where you already regularly shop.
Balance transfer cards
If you’re carrying a credit card balance, you may be able to save money by transferring that balance to a new credit card that has a lower interest rate. These are called balance transfer credit cards.
These cards don’t act any differently than other credit cards, but they generally offer a 0% interest introductory period on your transferred balances for 12 to 21 months. But cards may charge a 3% to 5% balance transfer fee, and you’ll want to compare that cost to the potential savings before applying.
Zero percent cards
Like balance transfer cards, some credit cards offer new cardholders a promotional 0% interest APR on purchases. The promotional periods often last between 12 and 21 months, giving you time to pay off a large purchase without accruing interest.
Charge cards aren’t credit cards, but the two sometimes get confused. The primary differences are that a charge card may not have a preset spending limit, and you must pay your balance in full each month with a charge card or you’ll have to pay fees. American Express may be the most well-known issuer of charge cards in the U.S., although it also offers credit cards.
Important credit card charges and fees
Let’s be honest. There aren’t a whole lot of people who want to read through the fine print on their credit card applications, but there are a few things you should look for before applying.
Fortunately, federal law requires that certain credit card rates and fees be clearly displayed, so it can be easy to compare one card with another.
Most credit card companies use what’s called a “Schumer box” (named after current New York Sen. Charles Schumer) to display certain credit card rates and fees.
Interest rates and charges
- APR for purchases — The APR you’ll pay when you carry a balance from purchases you made with the card.
- APR for balance transfers — The APR on balance transfers may be different than your purchase APR.
- APR for cash advances — You may be able to withdraw cash with a credit card, and the balance could have a separate APR.
- Penalty APR — A higher APR that can be applied to future balances if you make a late payment or your payment is returned. It may apply to current balances if your payment is 60 days late.
- Grace period — How long you have between the end of your billing cycle and your due date.
- Minimum interest charges — The card issuer might have a minimum charge, such as 50 cents, if you don’t pay off your balance in full.
- Annual fee — Some cards charge you an annual fee each year to keep the card.
- Balance transfer fee — The fee you pay when transferring a balance to your credit card. It may be the greater of a percentage of the amount you transfer and a specific dollar amount.
- Cash advance — A fee you’ll pay to take out cash. It may be the greater of a percentage of the amount you take out or a specific dollar amount.
- Foreign transaction fee — Some cards have a foreign transaction fee, an extra few percentage points on top of your purchase amount if you buy something outside the U.S. or if it’s sold in a currency other than U.S. dollars.
- Late payment fee — The fee you’ll pay if you don’t make at least your minimum payment by the due date.
- Returned payment fee — The card issuer charges this fee if you tried to make a payment, but it’s returned.
Common mistakes to avoid
Credit cards and scores can be complicated, and it’s easy to slip up when you’re new. Here are a few common credit card mistakes you should try to avoid.
Carrying a balance
Some people incorrectly believe that carrying a balance and paying interest can improve their credit scores. While credit card issuers typically do report your balance to the credit bureaus, and it can affect your scores, you aren’t penalized for completely paying off your balance each month.
How do credit card companies make money?
Credit card issuers can make money when you pay interest on a balance or fees. But they also make money each time you use your card to purchase something, and they can make money from charging the merchant where you use your card as well. That’s one reason a card issuer might offer an attractive sign-up bonus or rewards period. The more often you use your card, the more money it can make.
Even if you can’t afford to make a full payment, try to make at least the minimum payment by your due date every month. If you’re late, you could have to pay a late payment fee, the penalty APR could kick in, and you may wind up with a late payment on your credit reports, which can hurt your scores.
You might be able to sign up for auto-pay for just the minimum payment amount to avoid mistakes, but be sure you have enough money in your checking account to cover the payment.
Forgetting about or completely avoiding annual fees
Some credit cards have an annual fee, and sometimes the issuer waives the fee for the first year. Mark your calendar for a year from the day you open an account, so you won’t get caught off-guard when the fee appears on your account. You may be able to avoid the fee by calling the issuer and closing your card or switching to a card that doesn’t have an annual fee. But be aware that closing a credit card could negatively affect your credit.
On the other hand, don’t assume that you should always avoid paying an annual fee. Sometimes a card’s benefits can be worth more than the fee.
Closing unused credit cards once they’re paid off
If your card charges an annual fee that outweighs the benefits you typically reap from the rewards program, you might be better off closing it. But for cards with no annual fee, it could be more beneficial for your credit to keep those accounts open.
Having more open accounts generally means a higher overall credit limit, which can help moderate your credit card utilization rate. If you close a card with a high credit limit, you could see your utilization rate go up and your scores fall.
Paying with a debit card instead of a credit card because of safety worries
Identity theft and data breaches are on the rise. Consumer protections against fraudulent charges are typically stronger for credit cards than they are for debit cards. Paying with a debit card can expose your bank account to the possibility of fraud, and it can take weeks to have fraudulent charges reversed.
In addition, if your bank account is drained, the money you need to pay your bills could be tied up while the bank investigates. On the other hand, by law, consumers can only be held liable for unauthorized charges on credit cards up to $50. With a debit card, your entire balance could be tied up if the fraud isn’t reported quickly enough.
Now that you know the ins-and-outs of what credit cards are, how they work, the advantages of using a card and the pitfalls you’ll want to avoid, it’s time to take action. Continue your financial education, and — if it makes sense — apply for a new card.
Learn how to improve your credit scores
Credit cards may not be your first foray into the world of credit — you could have student loans, an auto loan or another form of debt payments. But if you want access to some of the best credit cards — and lowest interest rates on cards and loan — you’ll want to learn what goes into your credit scores, how to build credit and how to improve your credit.
Pay down debts
Working on paying off debt and think a credit card could help? Find out what others have done — such as taking on new side hustles — to get a handle on their finances. Then consider the pros and cons of using a balance transfer card versus a personal loan.
Find a card that works for you
One person’s amazing credit card offer or rewards program could be a dud for someone else. There are hundreds of cards to choose from, and it can be hard to figure out which one is best. Start by examining your spending habits, setting a goal for how you’ll use the card (perhaps for rewards or a major purchase) and then choose a card that fits your needs.
Monitor your credit
Unfortunately, you can’t control when or if a large company has a data breach and your information is compromised. But you can take steps to spot errors or signs of identity theft. Sign up for Credit Karma’s free credit monitoring, and you’ll get a notification if there’s a significant change in your Equifax® or TransUnion®credit reports — a potential indication that someone is trying to open an account in your name.
Check out the following Credit Karma articles to keep learning:
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When you're trying to get out of credit card debt, a mix of planning and perseverance can help you reach that goal.
Choosing the best credit card is easy if you know your top priority, which could be improving your credit, paying less interest, getting cash back or earning travel rewards.