Best Credit Cards

How credit cards work

A credit card is a revolving line of credit that allows you to easily borrow money using your card. 

Your balance (how much you owe) increases as you use your credit card, and it goes down when you make a payment. What makes a revolving account different from an installment loan or non-revolving credit line is that you can borrow against your line of credit multiple times without having to apply for a new account. 

For example, you may have a credit card with a $1,000 credit limit—the highest your balance can go before your card will be declined for new transactions. If you make a $300 purchase, you’ll have a $300 balance and $700 in available credit.

The credit card billing cycle 

Credit card billing cycles can be confusing for new and experienced cardholders alike. Also referred to as billing periods or statement periods, your billing cycle will often be about 30 days long. 

All the transactions that occur during the billing cycle are added together to determine your bill for that period. Purchases, balance transfers, cash advances, fees, and interest can increase the balance, while payments, refunds, and credits can decrease the balance. 

On the last day of your billing cycle — the statement closing date — a bill is created based on the balance. Generally, a payment will be due after a 21-to 25-day grace period. However, your next billing cycle starts right away, which is what often confuses cardholders. 

For example, say you make a $300 purchase on the first day of your billing cycle (and don’t use the card for anything else). Your statement closes 30 days later, and your card has a 23-day grace period before your bill is due. In total, you get 53 days between when you made a purchase and when you have to pay the bill. 

If you use your card to make a $100 purchase a week after the statement closing date, your card account’s total balance increases to $400. However, your current statement will still reflect the $300 (it’s a snapshot that doesn’t change after the bill is created). The additional $100 is part of a new billing cycle and is part of the bill that’s due 23 days after the current billing cycle ends. 

How credit card interest accrues

Credit cards often have a high interest rate, which is the same as the card’s annual percentage rate (APR). The APR doesn’t account for fees that you may have to pay to open, keep, or use your card.

Here’s a quick overview of how and when you may have to pay interest:

• You won’t pay any interest on purchases. But only if you pay your entire statement balance every month.
• Interest kicks in if you pay less than the entire statement amount. Your minimum payment may be as low as $25, or a percentage of the statement’s balance. The remaining balance will roll over to the next month and be added to the next bill. 
• Interest accrues daily. Once you’ve made a less-than-full payment, interest will start to accrue daily. The daily rate is determined by dividing your card’s APR by 365.
• Interest accrues on previous and new transactions. Interest may accrue on your account’s entire balance, which means your new purchases will start to accrue interest immediately. 

One important concept to understand is that credit cards may have different interest rates for cash advances (when you withdraw cash from an ATM or at a merchant), balance transfers (transferring debts from other cards or into a bank account), and purchases. Your cash advance and balance transfer transactions may begin to accrue interest immediately, even if you’ve previously paid your bill in full.

Why use a credit card?

Some people run into trouble with credit card debt because they see their credit limit as how much they can spend. However, after “maxing out” their card and hitting the credit limit, they aren’t able to pay the bill in full and start accruing daily interest. Left unchecked, overspending on credit cards can lead to thousands of dollars in high-interest debt. 

Ideally, you can use a credit card like a debit card — only making purchases you can afford to pay for when the bill arrives. And there are different reasons you may want to have and use credit cards:

• Interest-free loans — If you use a credit card at the beginning of your billing cycle, you’ll have about 51 days until your bill is due. If you pay your bill in full, you’re getting a short-term loan without paying interest. 
• Rewards — Many credit cards offer rewards for using the card. These may come in the form of cash back, points in a card issuer’s rewards program, or miles or points in a partner company (such as a retailer, airline, or hotel chain).
• Zero liability protection — Most credit cards are covered by a zero liability policy, which means you won’t be responsible for unauthorized transactions. The card also won’t be directly tied to your bank account. This can make using a credit card safer than carrying and using a debit card or cash. 
• Purchase protections and insurance — Many credit cards also come with additional purchase-related benefits, such as extended warranties and travel-related insurance. You may even be able to get reimbursed if a product you bought is damaged or stolen, or if your travels are delayed or canceled. 
• Cardholder benefits — Some credit cards also come with additional benefits, such as complimentary memberships, loyalty status in travel programs, and statement credits on certain purchases. 
• Emergency option — If you don’t have savings for an emergency, a credit card could be another option. While credit cards have high interest rates, they can still be less expensive than a payday loan or high-rate installment loan.  

For those who are able to use a credit card to receive the benefits and then pay the bill in full to avoid interest, these benefits can make credit cards rewarding and exciting. Some people even get multiple cards and “hack” the systems — carefully planning their purchases and redemptions to maximize their rewards. 

The different types of credit cards

While all credit cards tend to work the same way, cards are often put into different categories based on their primary function or feature. Common categories include the folowing:

• Secured card —Secured cards are generally for people who are brand new to credit or are trying to rebuild their credit. To open a secured card, you’ll send the card issuer a refundable security deposit, which will generally determine your account’s credit limit. The card issuer can use the money if you stop making your payments, although you’ll still be reported late to the credit bureaus, which can hurt your credit. 
• Rewards card — Rewards credit cards offer you rewards for using the card to make purchases. The rewards can come in different forms, such as cash back, points, or miles. Rewards cards are sometimes also categorized by how you earn rewards, such as flat-rate cards that offer the same rewards rate on every purchase and tiered-rate cards that offer bonus points on purchases in select categories. 
• Travel cards — Travel cards are a subsection of rewards cards that have travel-related rewards and benefits. 
• Low-interest cards — Some credit cards have a low APR, which could make them a good option if you may revolve a balance. Smaller community banks and credit unions tend to offer the best low-rate cards.
• No-interest cards — Some credit cards offer new cardholders a promotional 0% APR offer that may apply to balance transfers, purchases, or both. You can use these to move balances to the card (a balance transfer fee may apply) or make purchases and then pay down the balance without accruing interest. But watch out, if a card only offers a promotional rate on balance transfers, your purchases may accrue interest until you completely pay off the card.
• Deferred interest cards — Retail cards may also have 0% APR deferred-interest offers. With a deferred-interest offer, you’ll have to pay all the interest that would have accrued if you don’t pay off the balance before the promotional period ends. With other 0% APR offers, interest only begins to accrue on remaining balances once the promotional period ends. 
• Co-branded cards — Some credit card issuers partner with other companies, such as retailers, airlines, and hotel brands, to offer co-branded cards. These cards tend to offer partner-specific rewards and benefits.

There’s often overlap between the categories as well. For example, you may find a co-branded rewards card that also has a no-interest offer. Or a secured card that offers rewards. 

Credit card fees 

In addition to a card’s benefits and interest rate, you may want to review the fees you’ll have to pay to open and use a card. 

• Annual fee — Most common on secured and rewards cards, some credit cards have an annual fee that you’ll have to pay to keep your account open. Card issuers may waive the fee for the first year to encourage people to apply.
• Monthly fees — It’s not common, but a few cards charge a monthly fee. These tend to be cards for people who have poor credit and limited options. However, it’s best to avoid a card with a monthly fee if possible. 
• Foreign transaction fees — Some cards charge a fee — often around 3% of the transaction amount — on purchases made outside the U.S. and in foreign currencies. 
• Balance transfer fee — If you move balances from a different card onto your card or transfer a balance into a bank account, you may have to pay a balance transfer fee of about 3% to 5% of the transferred amount. 
• Cash advance fee — Many card issuers also charge a 3% or 5% fee if you use your credit card to get a cash advance. There’s often a $5 or $10 minimum on balance transfer and cash advance fees. 
• Late and returned payment fees — You may have to pay a fee if you don’t make a minimum payment on time or your payment doesn't go through. These can get as high as $40. 

All of these fees can be avoided, either by choosing a card that doesn’t have the fee or avoiding fee-incurring actions. 

How credit card companies make money

There are four major credit card networks (the behind-the-scenes systems that make everything work) in the United States — American Express, Discover, Mastercard, and Visa. 

American Express and Discover are both operator credit card networks and issue credit cards. In contrast, Mastercard and Visa operate networks, but credit cards are issued by banks and credit unions, such as Bank of America, Chase, Citi, PenFed, and Wells Fargo.

Credit card issuers can make money in several ways:

• Interest — Card issuers charge and collect interest. 
• Fees — Card issuers may collect annual and usage-based fees. 
• Interchange — Merchants pay interchange fees when they accept credit cards, ranging from about 1% to 3% of the transaction amount plus a small, fixed fee. These fees get passed to the card’s issuer.

Interest payments tend to be the largest source of revenue for credit card issuers, followed by the interchange fees that merchants pay.