What is a credit card?

If you have a bank account, then you’re probably well-acquainted with debit cards, which draw from your checking or savings account to make purchases. Credit cards offer an alternative type of purchasing power, using money that isn’t necessarily in your possession and giving you the chance to make purchases you might not otherwise be able to afford. Each time a credit card is charged, you’re borrowing the credit issuer’s money and agreeing either to pay them back in full by the monthly payment date with no added fees or to reimburse them over a longer period of time with added interest.

Credit Card Payments

Each month, you will be expected to pay somewhere between the monthly minimum and your balance in full. Paying in full is ideal because it means the issuer will have no outstanding debts to which it can apply interest. Leaving a remaining balance at the end of the month, on the other hand, means more interest will be assessed on that balance. Your interest is measured in annual percentage rate (APR), and essentially serves as the company’s way of charging you for the luxury of paying them back at your own pace. If you are unable to pay the monthly minimum, an additional (often hefty) fee will be added to the outstanding debt, even as the interest continues to accrue. Each of these factors–the minimum payment, the interest rate, and the penalty for not paying the monthly minimum–varies from card to card, making every card unique in its allures and drawbacks.

Credit History and Score

The credit card company is willing to enter into this agreement because your credit history, measured by a credit score, indicates that you can be trusted to fulfill your end of the bargain. Your credit score is calculated based on multiple factors, including the amount you already owe to other companies, and is used to evaluate how much money the issuer is willing to lend to you (commonly called a “credit line”) and the interest rate attached to your account. A strong credit history, and the high credit score which it generates make you more likely to qualify for a card with lower interest rates, a higher credit line and more benefits. Your credit score also plays a vital role in other areas of your financial life, as companies will use it to determine whether you qualify for larger advances, like mortgages and car loans.

Quick Snapshot

In short, here’s what a credit card does, here’s how you pay it off, and here’s why it matters:

• A credit card allows you to borrow money from a company and make purchases you otherwise might not be able to immediately afford.
• Each month, you’ll be expected to pay between the monthly minimum and your full balance. The more you pay back, the less interest you’ll accrue.
• Good credit practice will result in a higher credit score, which is essential for taking out larger loans such as mortgages.

Do you think you’re ready for a credit card? You can read about different cards and apply for one >> here. 

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