How Credit Cards Work: A Beginner’s Guide
Explore our guide to find essential information on how credit cards work, their benefits and how to use them responsibly.
Bottom Line Up Front
- Credit cards can offer valuable benefits when you manage your spending and make payments on time.
- Unlike debit cards that use money from your bank account, credit cards use borrowed funds you’ll repay according to your payment schedule.
- Responsible credit card use helps establish your credit history, creating opportunities for larger purchases in the future.
Time to Read
10 minutes
May 19, 2025
Your life doesn’t always match up with your pay schedule. That’s why having access to flexible credit options is so helpful. Applying for a credit card can give you the freedom to make both small and large purchases when you need them, with the ability to pay the money back over time in a way that works for you.
Using your credit card responsibly is also a great way to build credit. Establishing good credit can open doors to exciting opportunities like financing a new home or car.
Consider this your beginner’s guide to credit cards—from how they work to using them wisely—so you can feel confident about making smart financial choices.
- What is a credit card?
- How do credit cards work?
- Different types of credit cards
- Applying for a credit card
- Understanding credit card statements
- What is a credit card balance?
- How do credit card payments work?
- How do credit card interest rates work?
- Common fees and penalties
- How credit cards affect credit score
What is a credit card?
A credit card is a financial tool that lets you borrow money up to a set limit for purchases and bills. Credit cards work differently than debit cards. With a debit card, you’re spending your own money directly from your checking account. With a credit card, when you swipe, tap or enter your card number, you’re borrowing funds from the credit card company with a promise to pay it back.
How do credit cards work?
Understanding how credit cards work is relatively straightforward. When you’re approved for a credit card, your card issuer provides you with a credit limit based on factors like your credit score, income and existing debt. This limit represents the maximum amount you can borrow at any given time.
Each time you make credit card purchases, your available credit decreases by that amount. As you make payments toward your balance, your available credit increases again. This cycle of borrowing and repaying is called revolving credit.
Understanding the different types of credit cards
Smart money tip
For those new to credit, secured cards are often one of the most recommended options to build or improve your credit. As your credit improves, you can move to cards with better rewards and benefits.
Applying for a credit card
Getting a credit card starts with an application, most of which can be completed online. You’ll typically receive a decision quickly (sometimes instantly). If you’re approved for a new credit account, your new card will arrive in the mail within 7-14 business days.
Whether you’ll be approved and how much credit you’ll have access to depends on the type of credit card you apply for as well as your financial health. Credit card issuers consider several factors when reviewing your application.
Credit score and history
Your credit score reflects how you’ve handled debt in the past. Most conventional loans require a score of at least 620.
Income and employment
You’ll need to provide pay stubs or tax returns to verify your income, as this helps issuers determine if you can afford to repay what you borrow.
Current debt obligations
Lenders examine your debt-to-income ratio using information from your credit report and application, which shows how much of your monthly income goes toward existing debts.
Length of credit history
Your credit report shows how long you’ve been using credit, with longer histories typically viewed more favorably by lenders.
Recent credit applications
Multiple recent applications can signal financial distress to lenders, so your credit report will show all inquiries from the past two years.
Smart money tip
Remember that each credit application generates a hard inquiry on your credit report. Space out applications and only apply for cards you’re likely to qualify for.
Understanding credit card statements
At the end of each billing cycle (typically 30 days), your card issuer creates a statement showing all transactions made during that period. Learning how to read and understand this document is an important part of responsible credit use. Each statement contains several key sections:
- Account summary: Shows your previous balance, payments, credits, fees, etc.
- Payment information: Details the minimum monthly payment amount and due date.
- Transaction details: Lists each purchase, payment and credit from the billing cycle.
- Interest charges: Explains any interest applied to your account, including the APR.
- Available credit: Indicates how much of your credit limit remains available for use.
- Rewards summary: Tracks points, miles or cash back earned from your spending.
When your statement arrives, it’s important to review all transactions to verify their accuracy. Contact your card issuer promptly if you notice any unfamiliar charges to protect yourself from unauthorized use.
Statement balance
This is the total amount you owed at the end of your last billing cycle. Paying this amount in full by the due date typically allows you to avoid interest charges on purchases. If you make the minimum payment, any unpaid amount becomes the remaining balance, which accrues interest if not settled fully.
Current balance
This shows all transactions on your account in real time, including purchases made since your last statement closed. Your current balance may be higher than your statement balance if you’ve made new purchases.
When you make a purchase, it may initially appear as "pending" until the transaction fully processes. This temporary status represents the time between when you made the purchase and when it officially posts to your account. Tracking pending purchases and your current balance can help you stay within your card’s credit limit.
How do credit card payments work?
Each month, your credit card statement is a reminder to make a payment toward the statement balance. Paying your credit card bill on time can help you improve your credit history and your creditworthiness. On the flip side, making late payments can have detrimental effects on your credit score. Thankfully, you'll have several convenient options for making payments:
- Set up automatic payments scheduled from your checking account.
- Pay online through your card issuer’s website or mobile app.
- Pay by phone using the customer service number on your card.
- Pay by mail using the payment coupon included with your paper statement.
- Pay in person at a branch location if your issuer has physical branches.
Your billing cycle repeats each month, with new charges added and payments subtracted from your balance. While paying the minimum balance keeps your account current, paying your full statement balance by the due date helps you avoid interest payments.
Smart money tip
For those new to credit, secured cards are often one of the most recommended options to build or improve your credit. As your credit improves, you can move to cards with better rewards and benefits.
How do credit card interest rates work?
If you don’t pay the full balance on your credit card each month, you’ll have to pay interest. Interest is the cost of borrowing money, typically expressed as an annual percentage rate (APR). This rate determines how much extra you’ll pay when you carry a balance from month to month. Your card may have several different APRs that apply in specific situations:
- Purchase APR: The standard rate applied to purchases when you carry a balance.
- Introductory APR: Often a temporary lower rate offered to new cardholders.
- Balance transfer APR: The rate applied to balances moved over from other cards.
- Cash advance APR: Applies when you withdraw cash with your credit card.
- Penalty APR: A higher rate that may be applied if you miss payments.
Interest is calculated based on your average daily balance throughout your billing cycle. The higher your balance and APR, the more interest you’ll pay. Making only minimum payments means carrying credit card debt (and paying interest on it).
Common credit card fees and penalties
As part of your credit card agreement, your issuer may impose fees on certain types of credit cards or card activities. These are extra costs that you’ll be responsible for outside of repaying borrowed amounts (and interest). Some of the most common credit card fees you might encounter include the following.
Annual fee
A yearly charge for card membership, typically associated with rewards cards offering premium benefits. Many credit cards come with no annual fee, making them excellent options for daily use.
Late payment fee
Charged when you don’t make at least the minimum payment by the due date. Setting up automatic payments ensures you never miss a payment deadline.
Over-the-limit fee
Applied if you exceed your credit limit and have opted in to allow over-limit transactions. Monitoring your balance regularly helps you stay within your credit card’s limit.
Balance transfer fee
Usually 3-5% of the amount transferred when moving balances between cards. Even with this fee, a balance transfer can save money if the new card has a significantly lower interest rate.
Cash advance fee
Charged when you use your credit card to withdraw cash, typically a percentage of the amount withdrawn. Using your debit card for cash needs is usually more cost-effective.
Foreign transaction fee
Applied to purchases made outside the United States, usually around 3% of the purchase amount. Look for cards that waive these fees if you travel internationally.
Smart money tip
Most credit card fees are avoidable with proper planning. Reading your card’s terms and conditions can help you understand what actions might trigger fees so you can adjust your habits accordingly.
How do credit cards affect your credit score?
How you use credit cards plays a big role in shaping your credit score. Lenders want proof of your ability to borrow money and repay responsibly. To get it, they’ll look at your credit score. The three major credit bureaus—Equifax®, Experian™ and TransUnion®—assess credit scores based on consumer credit card activity, among other factors.
Making on-time credit card payments shows lenders you’re reliable, which can boost the payment history portion of your score (35% of your total score). The amount you owe compared to your credit limits (credit utilization) makes up another 30% of your score. Credit utilization is a big factor in calculating your credit scores, so keeping that number low is generally recommended.
Credit cards can also help establish the length of credit history. Each time you use your card responsibly—paying on time and keeping balances low—you’re building a positive track record that can help you qualify for better interest rates on loans, mortgages and even more rewarding credit cards in the future.
Smart money tip
Navy Federal Credit Union members have access to the Mission: Credit Confidence® Dashboard, where you can monitor your credit score and be notified of changes to your score.
Good job! Credit cards use borrowed money while debit cards use your own money.
Try again!
Correct! You're doing great!
Oooh! Not quite right!
Exactly!
Almost!
Disclosures
This content is intended to provide general information and shouldn't be considered legal, tax or financial advice. It's always a good idea to consult a tax or financial advisor for specific information on how certain laws apply to your situation and about your individual financial situation.