How Do Credit Cards Work

There are more credit cards issued in the United States than there are people, and credit card debt accounts for a significant portion of the total personal debt in the US. but despite this, there are still some basic things about credit cards that millions of American consumers don’t know about.

How Does a Credit Card Work?

A credit card can be used to build credit and to make secret payments online and offline. It comes with a line of credit (set by the provider prior to issuing the card) that the user then spends.

All issuers charge an interest rate for using this card, but this rate only kicks in when the debt has not been paid off every month. Whatever you spend on a credit card over the course of any given month will need to be paid off at the end of that month. If it is, then you won’t owe the provider any money (some fees may be charged for certain transactions) and no interest will be owed.

So, if you have a $10,000 limit and you spend $2,000 during one month, then you will need to pay $2,000 off by the next month otherwise interest will accumulate. In any case, you will not be able to go beyond that $10,000 limit until you pay back any amount borrowed, and if you spend and owe the full amount, then you will only be able to use that card agin when you pay it off. In this situation you will also accrue additional debt in the form of interest.

How to Get Cash from a Credit Card

Does Credit Card Interest

You can use your credit card at an ATM in order to get cash. However, this is not recommended. These transactions are known as “cash advances” and they come with huge fees.

In most cases you will also need to pay interest on cash advances, even if you pay off your credit card balance every month. This means that as well as an instant fee charged for making the cash advance, you will also be charged a varying interest rate on the amount that you withdraw at the end of the month.

Each credit card provider has their own terms, but they will all charge you and many of them have a rule that states the amount you owe will be “either 5% or $5, whichever is greater”. They also charge a higher APR, sometimes as much as 29.9%. This means that if you withdraw $10, then it will end up costing you $18.

You should only do this in the event of an emergency and never get into the habit of doing it regularly.

How Does Credit Card Interest Work?

Credit card interest is not straightforward. It’s an annual percentage rate, but you pay it monthly and could be charged daily. To work out how much you will pay, take the APR they are quoting and divide it by 365, before adding that amount to your total debt each day.

For instance, let’s say that your debt is $10,000 and your APR is 30%. This works out at a total of .082191% every day. It means that your balance will grow by $9.2 ($10,009,02) after the first day and will continue growing by this amount until the end of the month, which means you will owe an extra $260, or $10,260 in total.

This interest is only charged when you fail to pay off the card, as mentioned above. If you have a limit of $1,000 and you spend $1,000 one month and then pay it off immediately (or any time prior to the repayment date) then no interest will be accrued and that $1,000 balance can be spent, paid off, and spent as many times as you want.

This initial payment date is considered to be the grace period. All credit cards have them and your main goal should be to make sure you pay off your debt within this period. If you do not, and you accrue interest, it’s still important to pay off as much money as you can every month as that reduces the total interest that you will be required to pay.

Can you Get Out of Credit Card Debt?

How Does Credit Card Interest Work

Getting out of credit card debt is not like student loan forgiveness, there is no get-out clause offered to people in certain jobs or situations. If you want to get out of your debt then you simply need to pay it off. However, there are some ways that you can make it easier and bring the total balance down:

  • Consolidate: If you have multiple credit card debts or multiple debts in general, you can consolidate them into one. This means that you take out a loan and use that to pay off all of your other debts, thus having just one debt and one low-interest rate to pay.
  • Get Help: There are debt management services that can help you if you’re struggling.
  • Bankruptcy: It should not be seen as an easy way out, but it is certainly an option if you feel like things are getting too much and you can’t see the light at the end of the tunnel.
  • Balance Transfers: You can move your credit card debt from one card to another, taking advantage of the 0% APR on balance transfers offered by most card providers during an introductory period of time.
  • Pay it Off: Take a look at our guide on How to Pay Off Your Credit Card to learn about the best ways you can pay off this debt quickly.

How do I Build Credit with a Credit Card?

This one is easy, you just need to use it and make sure that you pay off the balance at the end of every month. As discussed on our guide to credit scores, simply owning a credit card will also help to boost your card, but if you instantly default on your payments then your score will head in the other direction.

What is the Best Credit Card?

It’s a matter of personal opinion and your needs will always play a role. If you have no credit then you may be better off with a secured card that lets you build towards a positive credit score. If you have great credit then you should look for a premium credit card that has a number of benefits for high-spending consumers.

If your score is “good” and you spend a lot of money, then a rewards card may be the best option. There are also business cards and student cards—there are so many options out there that it’s hard to say which one is the best. To learn more, click on the hyperlinks and you’ll see the guides that we have written on these types of cards, as well as the ones that we believe to be the best.