Credit Cards

Credit cards allow a borrower to carry a month-to-month balance on purchases with a low minimum payment and, typically, accompanying interest fees. When you use a credit card, you’re borrowing money from the card’s issuer to make purchases. Credit cards can help you establish good credit if you pay the balance in full each month.

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APA Schell, J. (2022, July 18). Credit Cards. Annuity.org. Retrieved August 15, 2022, from https://www.annuity.org/personal-finance/credit-cards/

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Chicago Schell, Jennifer. "Credit Cards." Annuity.org. Last modified July 18, 2022. https://www.annuity.org/personal-finance/credit-cards/.

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Key Takeaways
  • Credit cards are open-ended loans that let you carry a balance with a low minimum payment and accompanying interest fees.
  • The interest rates on credit card debt are higher than other types of loans. It’s best to pay off your credit card balance in full each month to avoid paying interest.
  • Credit card benefits include the ability to build and improve your credit history, protect against fraudulent purchases and earn rewards like travel miles or cash back.

What Is a Credit Card?

A credit card is a type of loan that enables you to borrow up to a certain amount of money with no fixed time to repay the loan amount. Credit cards let you carry over a balance from month to month, and usually require a low minimum payment to be made each month to keep using the card.

The credit card company sets a limit for how much you can charge to the card, known as the credit limit on the account. Your credit limit may vary depending on factors like your income and credit score.

Parts of a Credit Card

In its physical form, a credit card is a thin, rectangular plastic card with information printed on the front and back. The front of the card usually contains the names of the issuer and the cardholder, the card’s expiration date and a 16-digit card number.

The back of a credit card features a black magnetic stripe, also called a magstripe, which is how the card transmits account information electronically. On the back of the card, you’ll find a box for the cardholder’s signature and a three-digit card verification value (CVV) security code. The CVV security number is most often used when making online transactions.

Anatomy of a Credit Card

How Do Credit Cards Work?

When you use a credit card to pay for a purchase, you’re borrowing money for that purchase from the company that issued your credit card. Each time you charge something to your credit card, you add to the card’s running balance.

Credit cards rack up a balance over the course of their statement period, usually a one-month term. At the end of the statement period, your credit card issuer will send you a bill for the amount you charged to the card that month. The statement you receive will show the balance on your card, the minimum payment you must make and when the payment is due.

If you don’t pay off the full balance of your card before the deadline, the unpaid balance will roll over to the next month and accrue interest, which is an additional amount you’ll have to pay off. Your interest rate is determined by the credit card issuer and is expressed as a percentage of the balance that you owe.

You might see the credit card’s interest rate referred to as the APR. APR, or annual percentage rate, refers to how much interest you’ll pay each year as a percentage of the balance. A low, or even zero, APR is more desirable as it means you’ll pay less interest when you carry a balance.

What Are Credit Limits and How Are They Determined?

Your credit limit is the maximum amount you can borrow using your credit card. The limit refers to the total balance the card can have, not the maximum you can put on the card with one transaction.

Your credit limit will not be determined by the credit card issuer until after you apply, as issuers assign different credit limits to individuals based on certain factors. Creditors will ask about your income and pull a credit report to learn about your personal financial situation.

Credit card issuers look at information like your credit score, income, debt as a percentage of your income and limits on your other credit cards to calculate a credit limit. Issuers want the limit to be high enough that you will use the card, but not so high that you spend more than you can afford to pay back.

Your credit limit may increase or decrease periodically as creditors review your financial circumstances and spending habits. If you get a raise or a better-paying job; if your credit score improves; or if you consistently pay your full credit card balance on time, the issuer may choose to extend your credit limit. On the other hand, your credit limit could decrease if your credit score drops; if you take on more debt; or if you miss multiple payments on your credit card bill.

You should check your credit limit regularly to make sure you don’t exceed it. Your credit card statement will tell you each month what your limit is. Exceeding your credit limit can lead to overcharge fees, increased interest rates or a decreased credit limit. If you consistently go over your limit, the card issuer may choose to close your account completely.

What Is a Credit Score?

Your credit score is a number showing lenders how likely you are to ‌pay off a loan. Banks, landlords and other lenders use credit scores to determine the risk of extending credit to someone. Having a good credit score can help you reach financial goals like buying a house, renting an apartment, getting better insurance rates and securing a business or personal loan.

Using credit cards responsibly is key to building and maintaining a good credit score. Credit scoring models like the FICO score and VantageScore weigh payment history more heavily than any other factor in determining your credit score, so paying your credit card bill on time and in full can significantly improve your score.

Another factor that influences credit score calculations is how much of your available credit you’re using, also known as your credit utilization ratio. Experts recommend keeping your credit utilization below 30% to avoid penalties for your credit score.

For example, say you have a credit card with a $3,000 credit limit. If your balance at the end of the billing cycle is $1200, your credit utilization ratio would be 40%. You’d want to ‌keep your balance on that card below $900, or 30% of your total credit limit.

How Easy Is It To Get a Credit Card?

The qualifications needed to get a credit card vary depending on the card issuer, but there are a few regulations that are the same across the board. For example, consumers must be at least 18 years of age to sign a credit card agreement.

Being approved for a credit card can be ‌trickier for people between the ages of 18 and 21 than for older applicants. After the Credit Card Accountability Responsibility and Disclosure Act (Credit CARD Act) of 2009, you must show proof of a steady source of income to get a credit card before you turn 21.

If you’re not yet 21 and cannot prove a source of income, you’ll need a cosigner to obtain a credit card. You can also apply to be an authorized user on someone else’s credit card.

You may have further trouble getting a credit card if you have a poor credit score or no credit history at all. In this case, there are alternatives you can pursue to build your credit. Certain types of credit cards, such as secured credit cards and student credit cards, help people with little or no credit history gain access to credit cards.

What Are the Different Types of Credit Cards?

Credit card issuers offer a wide variety of card types. Each kind of credit card is designed to accommodate the unique needs of consumers.

Types of Credit Cards
Unsecured
The most common type of credit card available, unsecured credit cards don’t require any security deposit as collateral.
Secured
In contrast to unsecured cards, secured credit cards require the cardholder to put down a refundable security deposit to fund and open the account.
Cash Back
Some credit cards offer cash back rewards programs where you earn cash based on a percentage of your purchases using the card, usually between 1% and 5%. These programs might offer additional cash back for certain types of purchases, such as gas, groceries or dining out.
Travel
With travel rewards credit cards, you earn points or miles that can be redeemed for travel-related expenses, such as airline tickets or qualifying hotel stays.
Small Business
Small business credit cards offer a line of credit for individuals with business expenses. Issuers generally gear the benefits and rewards programs of these cards towards the needs of business owners.
Student
These cards ‌help students in college build credit. They may be easier to qualify for than traditional credit cards and typically offer perks such as no annual fee.

Pros and Cons of Credit Cards

While credit cards are an important tool for building credit, they also have several drawbacks to consider. Before applying for a credit card, ‌weigh the pros and cons of having a credit card to see if it’s the right move for you.

Credit Card Pros and Cons
Pros
  • Responsible use helps build credit
  • Online purchases are more secure
  • Can dispute fraudulent charges
  • Many offer rewards programs
Cons
  • Temptation to overspend
  • High APR on unpaid balances
  • Late or missed payments hurt credit scores
  • Can carry hidden fees

Credit Cards vs. Debit Cards

Debit cards are used to complete transactions online and in stores just like credit cards. But there are some notable differences between the two types of cards that are important to understand.

When you swipe a debit card, the money to complete the transaction is taken directly from the checking account linked to the card. Paying with a credit card works differently. You’re essentially borrowing money from the card issuer that you must pay back when the balance comes due at the end of the billing cycle.

The other major difference between credit cards and debit cards is protection against fraudulent charges. Credit cards are generally recommended for online purchases over debit cards due to the extra protections that make combating fraud and getting a refund easier.

Most credit card issuers offer zero-fraud liability. This means that if a fraudulent transaction goes through on your credit card and you report it, the issuer will put the fraudulent charge on hold while they investigate the charge. You won’t be liable for fraudulent charges made with your credit card.

Debit cards also have some protection against fraud liability. But because the money comes directly from your bank account when swiped, how much you may be liable for depends on how soon you report the fraudulent charge.

Under federal law, you’ll only lose a maximum of $50 if you report your debit card lost or stolen within two business days after learning about the loss or theft. If you report the loss within 60 calendar days, your maximum loss is $500; after that, your potential loss could be all money in your debit account and any other linked accounts.

How To Use Credit Cards Responsibly

A credit card is both a great way to build credit and a pathway to high-interest debt that can take years to pay off. If you want to make your credit card work for you without racking up costly interest, you must use it responsibly.

The least expensive and most responsible way to use a credit card is to pay off your balance in full each month. By doing so, you won’t accrue any interest because you won’t have any outstanding debt. If your credit card offers rewards like cash back, you can even earn a little money just for using your credit card to make everyday purchases.

Here are some more tips for using credit cards responsibly:

Using Credit Cards Responsibly
  • Do your research to find a card with low interest rates and rewards that work for you
  • Never spend more on your credit card than you have in your bank account
  • Set up autopay so you never miss a payment on your credit card bill
  • Check your credit card statement regularly to make sure there are no fraudulent charges

How To Find the Best Credit Card for You

Every credit card has different interest rates, fees, benefits and rewards, so it’s worth shopping around to find the best credit card for your financial needs. Here are some factors to consider when looking at different credit card offers:

Comparing Credit Card Offers
Annual Percentage Rate
The annual percentage rate, or APR, refers to how much interest you’ll pay if you carry a balance on your credit card. You can expect a credit card to offer an APR between 15% and 23% on average.
Customer Service
If you have a problem, such as a declined transaction or a lost credit card, you’ll want to be able to reach out to the issuer’s customer service department at any time. Look for a credit card that offers a toll-free 24-hour customer service number you can call.
Fees
Some credit card companies might charge annual membership fees, but many do not. You might also see fees for making a late payment, going over your credit limit, or using the card to get a cash advance. Check the fine print to find out which fees apply to the credit card you’re researching.
Grace Period
The grace period is the amount of time you have to pay off your credit card balance once you receive your monthly statement. Credit card companies are required to issue statements at least 14 days before the due date to give consumers time to pay, and some issuers may give you more time, as much as 25 days, before charging a fee.

Who Are the Top Credit Card Issuers?

You’ve likely heard of most if not all the major credit card issuers in the United States. These companies provide credit services to millions of Americans, managing a combined total of almost $3 trillion in transactions in 2020.

Top Credit Card Issuers by Size
  1. Chase
  2. American Express
  3. Citibank
  4. Capital One
  5. Bank of America
  6. Discover
  7. U.S. Bank
  8. Wells Fargo

How To Apply for a Credit Card

The specific forms and information you’ll need to apply for a credit card will depend on the company that issues the credit card, but the basic steps are the same.

Applying for a Credit Card
You fill out an application.
You can typically apply online or in person. You may need to provide details such as income and housing information.
The credit card company conducts a credit check.
The issuer will look at your credit score and credit report.
Approval or denial of credit.
The issuer will let you know if they have approved you to receive a credit card.
You receive the new card.
You’ll receive your new card in the mail within one to two weeks of approval, along with information about your credit limit and other account details.
Please seek the advice of a qualified professional before making financial decisions.
Last Modified: July 18, 2022

22 Cited Research Articles

Annuity.org writers adhere to strict sourcing guidelines and use only credible sources of information, including authoritative financial publications, academic organizations, peer-reviewed journals, highly regarded nonprofit organizations, government reports, court records and interviews with qualified experts. You can read more about our commitment to accuracy, fairness and transparency in our editorial guidelines.

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