How Do Credit Cards Work?

Credit cards can be a convenient financial tool that help you build credit and provide a lot of benefits. Taking the time to learn how to use them strategically can help you get the most out of them.

What Is a Credit Card?

A credit card is a revolving line of credit that a bank or credit card company issues to a consumer. The customer receives a plastic card with a unique account number that they can make purchases with using their credit line, but they must pay the credit card company back. If you pay less than your full balance owed, you will be charged interest on your remaining balance based on the card’s annual percentage rate (APR). In general, if you pay your bill in full each month, you can avoid having to pay interest.¹

Types of credit cards

There are different types of credit cards that match various consumer needs and preferences. Some cards offer cash back or rewards points when you make eligible purchases, while others have special features like an introductory 0% APR offer.¹

Some cards target different types of consumers, such as students, travelers, business owners or people loyal to a particular brand or store. Credit cards also come in different levels, like no-annual-fee cards and premium cards that have an annual fee.¹

How to Get a Credit Card

To get started using credit cards, you’ll have to complete an application, which can be done online or by filling out a paper application you receive in the mail. The credit issuer will ask questions about your income and expenses (such as your mortgage or rent payment) and review your credit history and credit score to determine if you meet their qualifications.

If you are approved, you will be offered a credit card account with a specific APR and credit limit based on your creditworthiness. Your card will typically arrive by mail within 10 business days.²

How Credit Cards Work

Your credit limit is the maximum amount that you can charge on the card. Your interest rate will impact how much you will pay when you carry a balance from one month to the next.

Once you begin using the card for purchases, the transactions will add up throughout the month until you reach the statement closing date, which is when the billing period ends. At that point, you’ll be issued a statement with a due date and the minimum amount you must pay to keep your account in good standing.¹

You have to make at least the minimum payment, but it’s ideal to pay the balance in full to avoid being charged interest.¹ If you get into the habit of just paying the minimum while you continue to make new purchases, the debt may eventually become challenging to deal with.

Credit cards, credit reports and credit scores

Behind the scenes, credit card companies report your card activity to one or more of the three major credit bureaus — Experian, Equifax and TransUnion.¹ These are the companies that collect and compile information to create consumer credit reports. From there, your credit reports are what credit scoring companies use to calculate your credit scores, including the FICO® score.³

The two most important credit activities impacting your credit score are your payment history (whether or not you pay your bill on time) and the amount owed relative to your credit limit (known as credit utilization).³ If you have a $1,000 credit limit and owe $500, that means you are utilizing 50% of your credit.

Paying on time accounts for 35% of your FICO score, and amount owed accounts for 30%.³ To maximize these aspects of your credit score, pay your bills on time without fail and aim to keep your credit utilization below 30% (but as close to zero as possible).⁴

Benefits of Using a Credit Card

Credit cards have a lot to offer consumers who are able to manage them well.

Rewards and cash back programs

The idea that you can get rewarded for your everyday purchases is an attractive feature of many credit cards. The way it works is you simply use the card to make eligible purchases and then you accumulate earnings — either a percentage of cash back or points — in your account. When you’re ready, you can then redeem your earnings in a variety of ways depending on the card.

One type of cash back card rewards a flat rate, such as 1% to 2%, back on all purchases. Other cash back cards might offer bonus cash back for certain categories of spending, such as 3% back on groceries, 2% back on gas and 1% for all other purchases. After the cash back balance grows for a while, you can decide to apply it as a statement credit to pay down your balance or you can request a check or deposit for the cash amount.⁵

Credit card reward programs work in a similar way, but instead of cash, you get points (sometimes called miles). You can then redeem those points in a variety of ways, such as using them to book travel or purchase gift cards or transferring them to a partner travel loyalty program (such as an airline miles program).⁶

Building credit history

You need credit to build credit, and credit cards are often the first product people start with. There are credit cards specifically designed for new credit users that are easier to qualify for, such as student credit cards. You might also begin with a secured credit card, which requires you to leave a cash deposit that will serve as your credit line.⁹

As you use your cards, make consistent, on-time payments and keep your balances low, and your credit score will gradually increase.

Potential Risks Involved With Credit Cards

With credit cards, if you fall into bad habits like spending beyond your means, not paying your bill in full or missing payments, it can snowball into problems with debt and have a negative impact on your credit score. Here’s why:

Credit cards can have high interest rates and fees

It's not uncommon for the average credit card APR to be in the high teens to the low 20s depending on economic factors.¹⁰ Credit cards can also charge various fees depending on the card, including late fees, returned payment fees, cash advance fees and others.

Debt accumulation

With average credit card debt surpassing the $1 trillion mark for the first time at the end of 2023, according to TransUnion data,¹¹ it's clear that many Americans struggle to pay off their balances. If you’re living on a tight budget already, it can be hard to make a dent in your credit card balance, especially since it will keep incurring interest charges.

Fraud and identity theft

Credit card identity theft was the most common type of identity theft reported in 2023, according to the Federal Trade Commission, with 416,582 consumers filing reports.¹² That’s why it’s so important to monitor your accounts and your credit reports regularly so you can spot any potential fraudulent activity and report it quickly. The good news is that the vast majority of credit cards have zero liability, meaning you won’t be responsible for paying any fraudulent charges.¹³

Tips for Using Credit Cards Responsibly

Creating smart financial habits will help you avoid debt struggles and keep your credit score healthy. Follow this game plan:

• Create a budget. If you put limits on your spending and track what you spend, you can stay in control of your finances. The ultimate goal should be that for every dollar you spend on your credit card, you have cash available to pay it off.
• Pay bills on time. This is a must since it’s the most heavily weighted factor in your credit score.³ To be sure you never miss a due date, set up automatic payments for the minimum amount due as your backup plan and then manually log into your account to pay a higher amount or your balance owed in full.
• Monitor credit card statements. At the very least, look over your monthly statement carefully to make sure you recognize all the purchases. If you have a credit card app, you can also log in periodically to see recent activity. To keep an even closer watch, set up notifications so that you will receive a text or email alert when purchases are made.
• Avoid unnecessary purchases. Try not to be tempted to use your credit cards just because you have available credit. Think through the things you wish to buy to assess if you really need or want the item and to ensure you have a plan for how to pay it back.
• Be selective about new credit products. Over time, you may want to open new credit card accounts to take advantage of various benefits. Read the offers carefully to understand the terms as well as to review the costs of the card, such as if there is an annual fee. Having multiple credit card accounts can be good for your credit score as long as you are managing them responsibly.⁹ Just try to space out new credit applications so you’re not applying for too many in a short period of time since that can have a negative impact on your credit score.¹⁴

The way you use credit cards can have a huge impact on your overall finances.

On the one hand, you can make mistakes simply because you don’t understand credit. You can overspend, run up your balances plus interest, miss payments and end up wrecking your credit score. This can put you in a position where you may not be approved for future lending products at all or, if you are, your cost of borrowing will be higher.¹⁵

Or, you can move forward as a credit user who is armed with healthy habits. You know that it will benefit you to use your cards responsibly, pay your bills on time, keep your balances low, take advantage of benefits and perks and earn rewards that put extra money in your pocket. All the while, you can grow your credit score, which will help you access better products and more favorable interest rates for when you need to borrow in the future.¹⁵

Managing Health and Wellness Costs With the CareCredit Credit Card

If you are looking for an option to help manage your health and wellness costs, consider financing with the CareCredit credit card. Get the care you want or need with easy, flexible financing options that allow you to pay for out-of-pocket expenses over time.* Use our Acceptance Locator to find a provider near you that accepts CareCredit. Continue your wellness journey by downloading the CareCredit Mobile App to manage your account, find a provider on the go and easily access the Well U blog for more great articles, podcasts and videos.

Your CareCredit credit card can be used in so many ways within the CareCredit network including vision, dentistry, cosmetic, pet care, hearing, health systems, dermatology, pharmacy purchases and spa treatments. How will you invest in your health and wellness next?

Author Bio

Dawn Papandrea is a journalist with more than two decades of experience covering personal finance and consumer issues. She has written for leading financial publications and organizations, including U.S. News & World Report, Investopedia, Bankrate and others.