How Does a Credit Card Work?

In this blog, we’re going to talk about how credit cards work and how we can use yours to earn rewards build a strong credit history and get access to better loans and credit cards in the future but first the basics a credit card is tied to a revolving credit account at a bank when you charge a purchase to your card you’re essentially borrowing money from that bank the bank pays that store and you pay the bank back later you’re allowed to borrow up to a certain amount at a time this is known as your credit limit once you’ve reached your limit you can’t charge any more to the card until you’ve paid off some of your balance but before we go any further let’s talk about interest when you spend money on a credit card you’ll be charged interest on the amount you owe your balance you won’t be charged interest immediately though as there’s something called a grace period on all your credit card.

Purchases at the end of the month your credit card issuer will send you a bill your bill tells you your outstanding balance and the minimum amount you need to pay to avoid a late payment fee if you pay back your entire balance before the bill is due you won’t owe any interest but if you don’t pay back the full balance the remainder begins to accrue interest how much interest you’ll owe depends on how long it takes you to pay back your balance and your annual percentage rate or apr your apr is the annual cost of borrowing money but your credit card issuer will actually charge you daily interest once the grace period ends to figure out how much enters a cruise each day you just divide your apr by 365 and then multiply that by your balance for example if you have a balance of ten thousand dollars and a 26 percent apr you divide the 26 by 365 to get about 0.071 percent that’s your daily interest rate multiply this by your ten thousand dollar balance and you can see that you’d accrue about seven dollars and ten cents in interest that day leaving your new balance at ten thousand seven dollars and ten cents assuming you don’t charge anymore to the card but here’s where it gets dangerous the next day your credit card issuer applies your daily interest to your new balance in this case ten thousand seven dollars and 10 cents so your balance now grows by seven dollars and eleven cents that day bringing your total to ten thousand fourteen dollars and twenty one cents the next day you pay the same interest rate on this larger balance and suddenly you owe ten thousand twenty one dollars and thirty two cents it’s easy to see how it can quickly get out of control credit card debt can also hurt your credit score especially if you max out your credit card or spend close to your credit limit every month ideally you should only use 30 or less of your available credit to keep your credit score high so if you only remember one rule about using a credit card let it be this never charge more to the card than you know you can pay back at the end of each month if you pay for purchases and the month you made them you won’t have to worry about interest at all if you do carry a balance try to pay it down as quickly as possible reduce your spending don’t charge any more to the card and consider a balanced transfer card or a personal loan you can find loan and credit card recommendations on the ascent’s website so if a credit card can be costly why do we use them there are a few reasons first they’re a great way to help build credit and show that you can handle borrowed money responsibly you might want to take out a loan someday to pay for a house or a car and you’ll find few banks are willing to work with you unless you can prove you’ve borrowed money before and successfully paid it back the second reason is security this is especially important for people who shop online if an identity thief gets a hold of your credit card number and makes a bunch of fraudulent purchases all you have to do is call your credit card company explain the problem.

And it will remove the fraudulent purchases from your bill and send you a new card this is a lot safer than using a debit card to shop online as that’s tied directly to your bank account if an identity thief gets that number they could potentially drain your savings but most people’s favorite reason for using credit cards is the rewards these vary depending on the type of card you have you can either get direct cash back or gift cards to popular retailers from cash back cards travel rewards cards give you miles you can use towards airline and hotel purchases and sometimes other perks like free travel vouchers bounce transfer cards have zero percent introductory apr periods that are great for those who are trying to pay off their existing credit card debt or finance the cost of a new purchase with a zero percent introductory apr for purchases and then there are some rewards that are less well advertised things like purchase protection which will reimburse you if something you bought with the card is damaged or stolen you can find a full list of benefits for a given credit card by reading through its cardholder agreement if you want to get the most out of your credit card you should choose one with the rewards you want that also matches your spending habits use this card as often as you can to earn rewards faster but never lose sight of the bill that will come at the end of the month it will almost always cost you more to carry a balance than you’ll get from any rewards benefits so you should avoid overspending at all costs a credit card can be a great tool for building your credit shopping safely online and getting rewarded for purchases you are going to make anyway but you have to use it responsibly or it could end up making your life a bit more difficult keep these tips in mind when shopping with a credit card to stay out of debt and get the most out of your card.

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