How Does a Credit Card Work?

Credit cards get their name because they are a line of credit. This means when you buy a product with a credit card today, you’ve used the banks money, not your own. This makes credit cards enticing because users can buy nearly anything today without having the money to afford it. Although lines of credit need to be repaid, this is the danger of credit cards for undisciplined spenders.

Credit cards come with a credit limit specific to the card holder. This limit is the maximum amount of money the holder is allowed to borrow before they can no longer use the card. When someone says they “maxed out” their credit card, it means they reached their credit limit. Paying back the money owed will allow the holder to use the card as normal again.

Paying Back Your Bills

At the end of your credit card payment period (usually this is monthly), you will be issued a bill equal to how much money you borrowed/spent. You can pay this in full, pay a minimum, or pay an amount in between. Card holders should always pay their bill fully since credit cards have extremely high interest rates. Interest rates for credit cards are currently in the 20%’s. At this interest rate, if you never paid a dollar towards your balance (debt), it would double in just 3 years…

The way you pay your credit card bill is reflected by your credit score. Your credit score is a financial report card that informs lenders how risky you are to lend money to. The score is a three-digit number that ranges from 300-850, the closer you are to 850, the less risky you are considered. Failure to pay your credit card bills will result in sharp drops to your score. Lower credit scores will affect your life in the following ways: higher interest rates on mortgages, higher interest rates on auto loans, inability to qualify for loans, denials when applying for an apartment, and other negative effects.

The best advice for credit cards: If you can’t afford it today, don’t buy it. Pay off your bill in full every month.

The Importance of a Credit Card

Credit Cards aka lines of credit will create your credit score. Another name for credit score is FICO score. Your FICO score is a beacon of light telling lenders your likelihood of paying them back. When you’re disciplined with a credit card paying the balance in full every month, you will be rewarded with a higher score. High scores improve your life by lowering your interest rates and providing a smooth rental application process.

For most people, a credit card is their first experience borrowing money. Generally, you want to avoid debt in your life. However, you need to have some history proving to lenders you are capable of paying it off. If you never have a loan or credit card, you will not have a credit score. No credit score is basically equivalent to having a terribly low credit score. No score tells a lender “This person has no experience paying off debt, be very careful when giving them money”. For this reason, having a credit card in college/high school is a scary but important step in one’s financial journey.

Additional Credit Card Benefits

Besides a FICO score and being able to borrow money, credit cards offer other important benefits. Here are some additional benefits credit cards offer their card holders:

• Cash Back: This is like a rebate when using your card to pay. Normally cash back is 1-2% of a purchase price adding up slowly over time. At 1% cash back, you’ll receive a dollar for every $100 you spend. It isn’t much, but it can add up over time and it’s “free” money.

• Airline Credit Cards: Most airlines have a rewards credit card that offer you points/miles when you swipe. As you spend with this card, you’ll have redeemable points you can use for future flights.

• Retail Store Credit Cards: Some retailers have their own credit card products. Using these cards is similar to airlines, but instead of miles you’ll get access to special pricing, discounts, and benefits at that specific store.

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