Credit cards can be useful tools -- when used properly. Used improperly, however, they can wreak havoc on your credit history and lifestyle.
A credit card is essentially a line of credit. The bank that backs the credit card gives you a credit limit, and you can charge up to that credit limit. The card can be used anywhere that accepts that particular card (Visa, MasterCard, American Express, Discover), and many stores will offer credit cards that are only good at that specific store (Best Buy, Macy's, Home Depot, etc.).
A minimum payment is due each month. You will receive a statement from the bank indicating your new balance (how much you owe the bank) and the minimum payment due (the least amount you have to pay that month). If you pay at least the minimum payment by the due date, you will avoid late charges and penalties. If not, there will be hefty fees tacked on to your balance. If you pay the balance off in full by the due date, you will avoid interest charges. If not, you will start paying interest on the balance.
The interest rate basically indicates how much, in addition to the balance that you've charged, that you owe the bank if you don't pay them in full. The interest rate is usually an annual percentage rate (APR), with the actual dollar amount varying depending on your current balance. The actual calculation to determine the dollar amount you're charged gets complicated, and involves average daily balances and possibly compounding interest, depending on the terms.
The interest percentage will vary depending on the bank that backs the card, your credit score, and your history with that card. Interest rates can vary widely, from introductory rates of 0% to rates of 50% or more for those with poor or delinquent credit.
When you first apply for a card, many banks will offer introductory rates. This means that for the specified length of time (six months, one year, etc.), you will receive the reduced introductory rate – often a much lower rate than the standard APR. Once the introductory period has passed, the standard APR will apply. Depending on the terms, the higher interest rate may start at that point, or the higher interest may have been accruing since the beginning, meaning a large amount of interest that you've built up will be tacked on to the balance.
Some retailers will offer deferred financing, which means as long as you pay the balance in full by the end of the option term, you will pay no interest. As with introductory rates, what happens after that will vary. In many cases the interest accrues from the beginning and will be added to the balance if the balance is not paid in full by the end of the option term.
In cases of deferred financing, if the minimum payment is not made on time each month, the account may switch to a regular account, with interest being added each month on the balance. Read your terms for more specific information.
Each bank is different, and as a result will charge different fees. Common fees are as follows:
- Late payment charges: If a payment is late, meaning it was not paid by the due date indicated on the statement, a fee will be added to your balance.
- Over-the-limit fees: If you charge more than your credit limit, a fee may be added to your balance.
- Annual fee: Some cards, especially those that offer special perks or incentives, will add an annual fee, just for having the card. Even if there is no balance on the card, the annual fee will be owed.
If you're trying to build your credit and find yourself unable to get a regular credit card, some banks will offer secured cards. What this means is that you give the bank a specific amount of money, and the bank gives you a credit card with that limit. As you make your payments on time, the terms of the card may change, and you can get that initial deposit back.
The purpose of a secured card is to build a credit history and raise your credit score. By having an initial deposit from you, the bank knows they won't lose as much money if you don't pay your bill. You can build credit, and they don't have to take the risk that you'll default.
Many credit cards now offer rewards, from cash back to gift cards to airline miles to merchandise. Terms vary widely, but the basic concept is that a percentage of the amount of your purchases is given back to you in the specified manner. For example, you may get one percent of your purchases as cash back. In this example, you build up a rewards balance and either request a check or automatically receive a check when you've hit a certain balance.
Sometimes specific retailers will offer credit cards with rewards that can be used at that specific retailer, encouraging future purchases. You can earn gift cards over time, based on a percentage of your past purchases.
When you receive a credit card that offers rewards, the bank should also provide you with specific information regarding the rewards program.
In an attempt to get your business, some banks will offer balance transfer offers. This means that you can transfer the balance of one credit card to another credit card, either one you already have or one you are applying for.
The benefit in transferring a balance is usually to lower the interest rate on the balance in question. Some cards will offer a zero percent balance transfer offer, for example, in which case you have a specified amount of time to pay the balance without interest. If the balance is not paid by the end of that time frame, you usually have to pay all accrued interest, at the current rate.
When you opt to transfer a balance, you can either do so online, or you will receive checks in the mail. Simply fill out a check to the bank whose balance you're transferring, and the balance will be applied to the new account.
There are fees involved to transfer a balance, usually a flat dollar amount or a percentage of the amount being transferred, whichever is higher. The paperwork you receive with such offers will indicate the amount you will be charged. It can seem quick and easy to transfer a balance, but keep in mind that each time you do so, the fees will be applied.
You cannot transfer a higher balance than your credit limit.