How Does a Credit Card Work? Understanding The Basics

Credit cards are invaluable in today’s society, but using them improperly can do more harm than good. Knowing the ins and outs of the various fees and interest rates can benefit your wallet along with your credit score.

Like most people, you probably receive enticing new offers everyday, but with so many credit card options, it can be hard to choose the best one for you. Follow along as we’ll be covering the basics of how credit cards work and how to choose the right one for your specific situation, along with some other details that most people aren’t aware of.

Annual Percentage Rate (APR)

You’ve probably received offers with no APR (Annual Percentage Rate) or lowered APR for the first six months as an introductory rate. This amounts to the percentage of interest you would be paying annually, on top of what you owe.

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This only applies if you don’t completely pay off your debt by the end of the monthly cycle. The lower APR the better, however different rates are offered to different customers depending on “Credit worthiness“.  Your credit worthiness depends on a number of factors such as debt, monthly income, and your current credit score.

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Credit cards can also have “variable” rates, which means they can change as the direct result of the economy.

The Dangers of Minimum Payments

While it may sound tempting to only make the minimum payment every month, it’s much wiser to pay it off as quick as you can. Letting your debt pile up will result in paying more interest on the amount owed. If you have multiple credit cards always try to pay off the card with the highest interest rate first.

Interest Rates and Balance Transfer Fees

A balance Transfer fee is when a customer wishes to pay off one credit card debt with another credit card. This usually amounts to a fee issued by the credit card company, which may be 3% of the total balance or higher.

Since different cards have different balance transfer rates, make sure to choose the lowest rate on the card which is paying the balance.

After a balance transfer is made, there’s usually no grace period. However there may be an introductory rate on the interest charged for the amount transferred. Also, keep in mind that even if you had an introductory rate at 0%, carrying a balance may still result in you losing your grace period on purchases.

Cash Advances

Cash advances allow you to withdraw money from your card instantly. A card that allows cash advances can be quite handy in the event of an emergency situation. Usually a credit card will state the limit on the amount that can be accessed.

Just keep in mind you’ll have to pay interest on the amount immediately. Also, you may lose your grace period on purchases when having a balance due to a cash advance.

Rewards and Annual Fees

Make sure to read the fine print as some credit cards come with an annual fee. This is a fee for solely using the credit card company’s services. Not all credit cards charge an annual fee, but it’s more likely when the card offers perks such as redeeming points on certain purchases or frequent flyer mile points. You may also receive bonus points for spending money in certain places.

Some annual fees aren’t necessarily worth the extra perks being offered. To figure out if what’s being offered by the credit card is worth the fee, calculate how much you’ll generally spend on purchases which grant you the most points.

Also take note that some cards issue a cap on how many points can be redeemed. For example, if your card gives extra points when shopping at a certain grocery store, if the cap is at $5,000, anything spent after that will no longer give you bonus points.

You should also note that if you miss a payment or are penalized for any other reason, it’s likely you will not earn further points on purchases. It may even lead to having to forfeit the points you have already earned.

Other fees may apply such as if you miss a payment, even by a small amount. Some companies may even increase the APR of the card. This will likely depend on your credit history.

When choosing a card make sure to read through all the details of what fees are mandatory and what fees may apply in certain situations.

Additional Penalties

Maxing out your credit limit or consistently having a high balance can also trigger an APR increase. This can also happen in the event of a payment which has been returned. Carefully read the terms of agreement to be aware of what circumstances can result in a penalty.

A credit card company has to notify you 45 days before they increase your APR, so it won’t catch you off guard if they do. In the event of a penalty, call your credit card company and ask how long the penalty will be in effect and if there will be additional rate increases or penalties. The company will tell you the approximate amount of time the penalty will be in effect for. Keep note of this and contact them when that time has been reached to ask for the penalty to be removed.

It’s also possible that the penalty may never be removed and the APR of the card will remain at a higher rate. If there is a penalty based APR on your credit card, this may show on your record, or may be disclosed when applying for a new credit card. If you are worried you might miss a payment, look for a credit card which has a low penalty based APR.

When utilized properly, credit cards are an essential tool for everyday life. While it’s easy to just apply for any credit card, weighing the options set by the credit card company can have a major cost impact. Carefully read through a credit cards terms before applying and actively monitor your credit card usage. By ensuring a credit card is used properly, you can keep your financial history in good standing, save money, and reap all the rewards being offered.

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