Credit Cards: Definition, Types, & Rates

What are Credit Cards?

Credit cards are like short-term loans on plastic. Banks, credit unions, and some retail stores let you borrow money up to a limit to pay for purchases. You can repay the charges in full by the end of the pay period to avoid interest, or you can carry a balance and pay back the borrowed amount, plus interest, over time. If used responsibly, they offer rewards and build credit, but if misused, they can lead to debt. Using a credit card responsibly is one of the easiest ways to build up good credit, reflected in a credit score. Building good credit is important because it affects your interest rates on loans, mortgages, and even insurance.

Key Terms You Need to Know

Understanding key credit card terms is crucial for managing them effectively. Here are five essential terms:

• Annual Percentage Rate (APR): This is the yearly interest rate charged on unpaid balances, indicating the cost of borrowing with your card. A lower APR means you'll incur less interest if you carry a balance month to month, but paying your balance in full each month allows you to avoid these charges altogether.
• Credit Limit: The maximum amount you can borrow on your credit card. Staying within your limit and not maxing out the card helps maintain a good credit score and avoid incurring fees.
• Minimum Payment: The smallest amount you must pay each month to keep your account in good standing. Paying only the minimum can lead to higher interest charges and prolonged debt.
• Grace Period: A 15 to 21-day timeframe between the end of a billing cycle and the payment due date, during which you can pay your balance in full to avoid interest. Interest starts accruing if you carry a balance past the due date.
• Credit Score:A number representing your creditworthiness which is based on your payment history, credit utilization, and other factors. A higher credit score helps you qualify for better interest rates on loans, credit cards, and other financial services.

How it All Works

Credit cards are a financial tool that allows you to borrow money from a lender to make purchases or withdraw cash up to a certain limit. Here’s how they work:

1. Issuance: To obtain a credit card, you apply with a credit card issuer, such as a bank. The issuer evaluates your creditworthiness based on your credit history and income.
2. Credit Limit: Upon approval, you are assigned a credit limit, which is the maximum amount you can borrow at any given time.
3. Making Purchases: When you use your credit card for a purchase, the issuer pays the merchant on your behalf, and the amount is added to your card's outstanding balance.
4. Billing Cycle: Credit cards operate on a monthly billing cycle. At the end of each cycle, the issuer sends you a statement summarizing your purchases, outstanding balance, minimum payment due, and payment due date.
5. Grace Period: You typically have a grace period of 15-21 days to pay off the balance without incurring interest on new purchases. You avoid interest charges if you pay the full balance within this period.
6. Interest and Fees: If you don’t pay the full balance by the due date, interest is charged on the unpaid balance at the card’s APR. Additional fees may apply for late payments, exceeding your credit limit, or cash advances.
7. Rewards and Benefits: Many credit cards offer rewards programs, such as cashback, points, or travel miles, as incentives for using the card. Other benefits might include purchase protection, travel insurance, and extended warranties.
8. Credit Impact: Using a credit card responsibly by making payments on time and keeping balances low can help build a positive credit history and improve your overall credit score. Conversely, missed payments and high balances can harm your credit score.

Overall, credit cards provide a convenient way to manage expenses and earn rewards, but they require self-discipline to avoid accumulating debt and paying high interest.

Types of Credit Cards

There are many types of credit cards on the market, each serving a specific purpose and benefit for users.

Here’s a list of some of the most common types of credit cards:

• Low-Interest Credit Cards: These cards offer a lower APR, making them ideal for carrying a balance. They often have fewer rewards but help reduce interest charges.
• Rewards Credit Cards: These cards offer points, miles, or other rewards for purchases. Rewards can be redeemed for travel, merchandise, gift cards, or cash back.
• Cash Back Credit Cards: These cards provide a percentage of cash back on purchases. They often have different rates for various categories like groceries, gas, and dining.
• Travel Credit Cards: Designed for travelers, these cards offer rewards like airline miles or hotel points. They often come with travel-related perks, such as no foreign transaction fees, travel insurance, and airport lounge access.
• Secured Credit Cards: These cards require a security deposit and are typically used by individuals with poor or no credit history to build or rebuild credit. The deposit usually determines the credit limit.
• Student Credit Cards: Tailored for college students, these cards often have lower credit limits and may offer rewards for good grades or responsible spending habits. They are designed to help students build credit.
• Business Credit Cards: These cards are meant for small business owners and offer rewards and features tailored to business expenses. They can help manage cash flow, track expenses, and earn rewards on business-related purchases.
• Balance Transfer Credit Cards: These cards offer a low or 0% introductory APR on balance transfers for a specified period. They are ideal for consolidating debt from higher-interest credit cards.
• Store Credit Cards: Issued by retail stores, these cards can only be used at the issuing store or its affiliates. They often provide special discounts, rewards, and financing options but typically have higher APRs.
• Prepaid Credit Cards: These cards are preloaded with a set amount of money. They are not traditional credit cards, as they do not involve borrowing, but they can be used like credit cards for purchases until the balance is reached.
• Gas Credit Cards: These cards offer rewards and discounts specifically on fuel purchases. They may also provide benefits at gas station convenience stores and affiliated partners.
• Airline Credit Cards: Co-branded with airlines, these cards offer miles or points for purchases that can be redeemed for flights, seat upgrades, and other airline-related perks. They often come with benefits like free checked bags and priority boarding.
• Hotel Credit Cards: Co-branded with hotel chains, these cards offer points for stays and purchases that can be redeemed for free nights, room upgrades, and other hotel benefits. They often include perks like elite status and late check-out.
• Premium Credit Cards: These cards come with high annual fees but offer extensive benefits such as travel credits, airport lounge access, concierge services, and luxury rewards programs.

Each type of credit card has unique features and benefits tailored to different financial needs and lifestyles. Consumers should research the different types of cards and choose one that best suits their spending habits and goals.

Credit Card Rates and Fees

Understanding the different rates and fees associated with credit cards can help you manage your finances more effectively and avoid unexpected costs and fees.

Credit Card Rates

The most commonly used credit card rate is the Annual Percentage Rate (APR), which is the interest charged on unpaid balances. A lower APR means you'll pay less interest if you carry a balance.

A credit card APR is calculated with the following formula:

(Daily rate) x (Average Daily Balance) x (# of Days in Billing Cycle) = Credit Card APR

There are other types of credit card rates besides the Annual Percentage Rate. Some key rates to understand include:

• Purchase APR: This is the interest rate applied to purchases made with a credit card. It's typically the most commonly advertised rate and is a term often used interchangeably with the standard APR.
• Balance Transfer APR: This rate applies to balances transferred from one credit card to another. It is often lower than the purchase APR for a promotional period.
• Cash Advance APR: This rate is applied to cash advances, which are cash withdrawals made using the credit card. It is usually higher than the purchase APR and often starts accruing interest immediately without a grace period.
• Penalty APR: This higher interest rate is triggered if you miss a payment or violate other terms of the credit card agreement and it can significantly increase the cost of carrying a balance.
• Introductory or Promotional APR: Some credit cards offer a lower APR for an initial period (e.g., 0% APR for the first 12 months) on purchases, balance transfers, or both. After the promotional period ends, the regular APR applies.

Credit Card Fees

Credit card companies will charge fees for various reasons. Common fees include:

• Late payment fees: These are fees charged if you miss the payment due date.
• Annual fees: Some cards charge for membership.
• Cash advance fees: These are fees for withdrawing cash.
• Balance transfer fees: This is a fee that is incurred when moving debt from one card to another.

Before applying for a credit card, research the fees and charges associated with certain services.

Pros and Cons

The following table summarizes the pros and cons of some of the most popular credit card types to help you understand each card's potential benefits and drawbacks.

How to Apply for a Credit Card

Applying for a credit card involves several steps to ensure you choose the right card and increase your chances of approval. Here’s a rundown of how to apply for a credit card:

1. Check Your Credit Score: Your credit score impacts your eligibility and the terms you may receive. Obtain your credit report from a credit bureau to know where you stand.
2. Research Credit Cards: Compare different credit cards based on your needs—low interest rates, rewards, cash back, travel benefits, etc. Consider the APR, annual fees, rewards programs, and other benefits.
3. Prequalification: Some credit card issuers offer prequalification checks, which give you an idea of whether you’re likely to be approved without affecting your credit score.
4. Gather Necessary Information: Be prepared to provide personal information, including your Social Security number, income, employment details, and housing costs.
5. Submit the Application: You can apply online, by phone, or by mail. Fill out the application form with accurate and complete information.
6. Await Approval: The issuer will review your application, which may take from a few minutes to a few weeks. They will check your credit history, income, and other factors to decide.
7. Review Terms and Conditions: If approved, carefully read the terms and conditions, including the APR, fees, and rewards details. Make sure you understand the terms before activating the card.
8. Activate Your Card: Once you receive your card, follow the issuer’s instructions to activate it. This often involves calling a phone number or visiting a website.
9. Start Using Your Card Responsibly: Use your card for purchases, pay at least the minimum payment on time each month, and monitor your statements for any unauthorized transactions.

The Bottom Line

Navigating the credit card landscape can be challenging, but understanding the types, terms, rates, and fees helps you to make informed choices. Whether you're looking to build credit, earn rewards, or manage expenses, selecting the right credit card tailored to your needs can help you achieve your financial goals and maintain healthy credit.