How credit cards work
Quick insights
- Credit cards allow you to borrow money against your credit limit.
- If you don’t pay off your credit card on time, you may be subject to interest and fees.
- Different credit cards may provide benefits like cash back rewards, points, airline miles, travel benefits and more.
Credit cards are a common way to make purchases, pay bills and help manage debt in some cases. They can be quite convenient and typically offer the chance to earn rewards.
Below, we'll break down some things you may want to know about credit cards, including:
- What is a credit card?
- How does a credit card work?
- The difference between debit and credit cards.
- Types of credit cards.
- Why get a credit card?
- How to get a credit card.
- Tips for using a credit card.
What is a credit card?
A credit card is a form of revolving credit—meaning you borrow money against your available credit. When you open an account, you agree to pay back this money to your credit card issuer.
This concept of borrowing money makes you the "borrower" and your card issuer or issuing bank the "lender." As a result, the lender reports your payment activity to the credit bureaus, and your payment history is one factor in determining your credit score, a figure that represents your creditworthiness.
Before we explain how this works in more detail, here are some important credit card terms to know:
- Annual fee: The fee which some cards charge once per year for use of the card.
- Balance: The amount of borrowed money on your card that you have not paid.
- Credit limit: The maximum amount you can borrow on your credit card.
- Credit card network: Credit card networks authorize and process credit card transactions. They facilitate the information transfer between merchants and issuers.
- Interest/APR: Interest is the price you pay to borrow money. The interest rate charged by a credit card company is typically stated as a yearly rate called the annual percentage rate (APR). Interest is charged during every billing cycle you have any unpaid balances. Your credit card may also have different APRs for balance transfers, cash advances and purchase balances.
- Issuer: This is the bank or financial institution that provides you your credit card. You make payments to your credit card issuer.
- Minimum payment: The minimum payment consists of a small percentage of your balance, plus accrued interest and fees. The minimum monthly payment is due on or before the due date.
How does a credit card work?
Credit cards are often used for making purchases and paying bills. When you use your card for a purchase, a few things happen in the span of several seconds:
- You swipe, insert or tap your card at the card reader when checking out in person. If you're paying a bill or shopping online, you'll enter your card's information instead.
- The merchant contacts your credit card issuer through the credit card network to request an authorization for the transaction.
- If approved, the transaction will go through and money will transfer from the issuer to the merchant.
Every billing period (approximately 28 to 31 days), you receive a statement containing all of your transactions for that period, your total balance and your minimum payment. You may get a grace period, which is usually 21 days but varies by issuer, to pay at least the minimum amount due.
If you don't pay the full balance, your issuer charges interest based on your APR and remaining balance. The lender adds this interest to your balance. Making only the minimum payments may cause your interest charges to grow, whereas paying your full balance means you pay back only what you owe and may not accumulate interest charges.
The difference between debit and credit cards
The primary difference between credit and debit cards is that credit cards let you borrow money, whereas debit cards draw on money you already have.
This distinction means a lot for your finances. For one, credit cards let you borrow money and expand your purchasing power beyond the money you have. With debit cards, you use the money you already have in your banking or checking account.
Because you're borrowing money with a credit card, how you use it may affect your credit score. In most cases, debit cards don't affect your credit because you can only use money you have available in your bank account.
Types of credit cards
There are several types of credit cards to choose from, each designed for different users:
- Personal credit cards: Personal credit cards are designed for everyday spending, such as gas, groceries, entertainment, car repairs and dining at restaurants.
- Business credit cards: Business credit cards are intended for business-related purchases. For example, if you purchase office supplies for your home office or travel frequently for work, you can use your business credit card. Business credit cards help separate your business and personal expenses.
- Secured credit cards: Secured credit cards require a cash deposit as collateral, and your limit is usually equal to or greater than the value of the cash deposit. Keep in mind Chase does not offer secured credit cards.
- Unsecured credit cards: Unsecured credit cards don't require any cash deposits. The lender determines your credit limit based on your credit report, gross annual income and other variables, depending on the company. Most traditional credit cards are unsecured.
Credit card rewards
Many credit cards allow cardmembers to earn rewards on eligible purchases. Depending on your card, you may earn rewards in the form of:
- Cash back
- Points (typically exchanged for cash back, travel, gift cards or statement credits)
- Airline miles
Credit cards may also come with additional benefits. For example, some travel credit cards may offer benefits like annual travel credits and airport lounge access.
Why get a credit card?
Credit cards offer a variety of benefits whether or not they charge annual fees. Here are some examples:
- Sign-up bonuses: Also known as new cardmember bonuses, signup bonuses are offered by many cards. Issuers may pay you a one-time bonus for spending a certain amount within a period after you open the account.
- Rewards: Some credit cards help you earn rewards that can be redeemed toward travel, gift cards, cash back and more.
- Balance transfers: A card may offer a promotional APR on balance transfers for a duration, giving you time to pay off debt. You might also want to consider consolidating other credit card balances this way.
- Introductory purchase APRs: When you open a new credit card, it may offer an introductory APR on purchases for a period of time. This could help you pay for large purchases.
- Building your credit score: Using a credit card responsibly and paying off your monthly balance on time can be an important factor in improving your credit score. A higher score can help you obtain better rates and terms on future lines of credit.
How to apply for a credit card
Interested in applying for a credit card? Here are the basic steps of the application process:
- Apply: After you decide which credit card you are interested in, you can apply. Some issuers prequalify you for a credit card, meaning they’ve done a preliminary credit check and think you could qualify for the card.
- Complete the application: Once you've decided on a credit card, you'll need to provide basic info about yourself and estimate your income.
- Authorize the hard credit check: Give the issuer permission to take a formal look at your credit history.
- Receive a decision: The issuer evaluates your credit and sends their decision, usually within 30 days. If the account is approved, you'll receive your card in the mail.
Tips for using a credit card
Credit cards can cause damage to your finances and credit when used irresponsibly. A few steps you could take to potentially improve your credit score include:
- Set a budget: Avoid credit card debt by setting and sticking to a budget. Make sure your spending stays below your income.
- Try to pay at least the minimum payment on time every month: If you don't carry a balance, you may not be charged interest.
- Use your card for everyday purchases: You may have to buy things at gas stations and grocery stores, and many cards offer rewards on those purchases.
- Monitor your score: Access your credit score regularly using Chase Credit Journey® to see how you're progressing. Make sure you don't see any errors that could be harming your score, and if you do, report them promptly.
Keep in mind that many factors influence your credit score, and there’s no guarantee that following these steps will improve your score.
In summary
Using a credit card allows you to borrow money against your credit limit. However, you may want to familiarize yourself with specific details about your credit card, including its credit limit, interest rate, possible annual fee, APR and minimum payment. This way, you can review how the card works and the fees that may apply, and how you can potentially avoid incurring some of the fees. It can also be useful to understand your card’s rewards structure to help make the most out of your credit card.
