- On the surface, using a credit card is easy; you just swipe, tap, or insert to pay.
- It’s important to understand how credit card payments and interest work too, so you can avoid large interest fees.
- The key to using a credit card responsibly is to pay off your balance in full each month.
- This will let you reap the benefits, like cash-back rewards and bonus points, without putting yourself in debt.
- See Business Insider’s list of the best credit cards »
Using a credit card is as simple as swiping or inserting it at checkout. But it’s also important to understand exactly what goes on behind the scenes when you hand it over the counter, plus how to use your credit card responsibly, so you can improve your financial health in the long run.
How to use a credit card
Much like a debit card, a credit card is a piece of plastic connected to an account that you can use to pay for goods and services, both in person and online.
If you already have a debit card, then you’re most of the way there, as responsible credit card use functions in much the same way.
When you want to pay for something in person, you’ll either hand over your credit card to the cashier, or swipe, tap, or insert it into the merchant’s credit card reader. To pay online, you’ll type in the account number embossed across the front of your card, along with the expiration date and a short code on the back that proves you’re actually in possession of the card.
When it comes time to pay your credit card balance, you’ll do that by logging into your credit card account and connecting it to a checking account from which you can transfer funds to pay off your balance.
The main difference between a credit and debit card is the status of the money used to pay for the purchase. With a debit card, you’ve already earned that money, and it’s sitting in your account, ready to be used. Once that account is empty, you’ll need to add more money to it before you can continue to pay with your debit card.
But for a credit card, the connected account doesn’t actually have any cash in it. Instead, you’re making your purchase on credit — your credit card company is essentially spotting you the money in advance, up to a set amount that’s known as your credit limit. Your credit card company does this with the understanding that you will pay it back in full at a later date, and that you’ll pay interest on the funds if you end up owing more than you’re paying. (A practice called carrying a balance.)
How to pay off a credit card
While it can be tempting to pay the minimum amount due, experts agree that the best practice is to pay your balance in full at the end of every month. (Basically, treat your credit card like a debit card by staying within your means and trying not to spend money that you don’t have.) That’s because interest can quickly pile up on any charges that are carried over from month-to-month.
According to data from the Federal Reserve, the average credit card interest rate in the United States is 14.52% — although your own annual percentage rate (APR) will vary based on your credit score and card.
Using the average, though, that means if you pay off all but $100 on your credit card at the end of your billing cycle, you’ll suddenly find yourself with a $114.52 balance at the start of the next one. That interest accumulates quickly, and can set you sliding down a slippery slope toward debt, so do yourself a favor and set up automatic bill pay so that you never get dinged by interest or late fees.
What’s going on behind the scenes?
Charging interest on outstanding balances is one of two ways that credit card companies make money off of cardholders. Understanding the other requires an explanation of how, exactly, credit cards work.
When you swipe your Visa credit card at Whole Foods, for example, the retailer (Whole Foods) sends your information to your credit card network (Visa) and a message to your bank (Chase) asking if the charge would keep you within your credit limit. If the answer is yes, Chase authorizes your purchase and puts a hold on your account in the amount of the charge.
At the end of each day, Whole Foods sends all of its credit card transactions to the appropriate credit card networks for processing. Visa receives a record of your transaction, and reaches out to your bank for the money. Chase sends the funds to Visa, holding back some nominal fees for itself, and Visa sends the amount on to Whole Foods, again withholding some small fees.
These are called interchange fees, and they allow both your bank and your credit card company to make money on every single purchase you make. Which is why so many companies offer compelling rewards like cash back, low introductory APR, sign-up bonuses, and increased points and miles on certain purchases.
How do I get a credit card?
As long as you’re over the age of 18 and have a Social Security number, credit history, and verifiable income, you’re eligible to apply for a credit card.
You’ll want to do some research to see which card is best for your particular credit score and situation, paying close attention to its interest rates and any annual fees. When you’ve found one you like, the application process is often quite simple and can be completed online in just a few clicks. Look for an “Apply Now” button, and be prepared to answer a combination of biographical and financial questions that shouldn’t take more than five minutes or so.
After submitting your application, you should find out whether you’re approved within two weeks. If you are, you could have your credit card in hand 10 to 14 days after that. And if you aren’t, there are some great starter credit cards to consider while you build up a stronger credit history.
No matter which direction you take, however, remember that the smartest way to use a credit card isn’t as free money, but as an expense to be paid off in full at the end of each month. Taking that lesson to heart can help you dodge the nearly $3,000 of credit card debt that the average American cardholder is currently carrying.