How Credit Cards Work - Credit Card Basics | MakingCents

Borrowed Money

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Your life doesn’t always match up with your pay schedule. That is why it’s nice to know you can borrow money. One way to do this is through the use of a credit card. This option allows you to make small and large purchases alike and then pay them back over time. Responsible use of a credit card can also help you build credit, which you’ll need to take out future loans.

To determine if you should begin borrowing from a lender, ask yourself 3 simple questions:

Do I really need this?
Could I save for this and purchase it later?
If I borrow money, how long will it take me to pay it back?

Once you provide an honest answer to each question, you can choose to take advantage of the convenience and purchasing power of credit cards.

Revolving Credit

Borrowing with revolving credit, which is what you’re doing when you use a credit card, is like having a loan you can keep open indefinitely. With a credit card, you’re given a maximum amount you can spend—referred to as your credit limit or credit line. Once you've reached that limit, you won't be able to borrow any more money until you've paid the balance back down below the limit. Some cards will approve charges above your credit limit, then charge an over-the-limit fee. Here are two examples to illustrate how credit cards work:

Overspender			Savvy Spender
Credit Limit		$500	Credit Limit		$500
Billing Period		12/1-12/31	Billing Period		12/1-31
Monthly Spending			Monthly Spending
12/2	Restaurant Charge	$100	12/2	Restaurant Charge	$100
12/6	Clothes Shopping	$200	12/6	Clothes Shopping	$200
12/13	New TV	$350	12/13	Netflix subscription	$8
Total Spent		$650	Total Spent		$308
Remaining credit line		-$150	Remaining credit line		$192
Over-the-limit fee		$100	Additional fees		$0
Interest rate hike		From 13% to 20%	Interest rate hike		None

Each month, you can choose to pay less than the total due (as little as the minimum required payment), allowing the remaining balance to carry over into the following month’s statement. However, any unpaid balance will be subject to interest, which is a fee charged for the borrowed money. Keeping a balance from month to month means you’ll end up growing debt that accumulates interest charges.

An example:

Amount charged: $500
Interest rate: 10%
Minimum payment: 2% or $10, whichever is greater
Number of monthly payments: 65
Total time to pay off: 5.4 years
Total interest paid: $159.50

Choosing a Credit Card

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Text, Making Cents, Choosing the Right Credit Card.

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When it comes to credit cards, it pays to pick the best option.

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Green text, Choosing and Managing your Credit Card.

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Here's what you need to know to make the right decision. First, understand that a credit card is actually a loan without a set repayment schedule. You can pay as little or as much as you want, as long as you make a minimum payment by the monthly due date.

Some credit card terms you should know include credit line. This is the total amount you can charge to the card. The APR is the interest rate charged on unpaid balances. And the grace period is the number of days you have to pay your balance in full before interest starts accruing.

Compare rates and fees, then select the card that offers the lowest for both. Take the time to fully understand the terms and conditions. If you pay off your balance every month, a low annual fee is more important than a low interest rate. You'll pay off your balance before interest accrues. But if you usually carry a balance from month to month, you'll probably want to choose a card with a low interest rate, even with an annual fee.

Here are other key questions to consider.

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If you fall behind on payments, your interest rate can increase. You may face a late fee or lose points in rewards. Your credit score might also be affected, which can make it more difficult to get approved for future loans. Don't be fooled by a credit card with a six month introductory interest rate, unless you plan on paying off your balance during that period. The regular rate-- the one you'll pay when the promotion expires-- is much more important.

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A cartoon light bulb appears above the word Tip. Text, Interest rates on credit union credit cards cannot be higher than 18%, Some financial institutions don't cap their credit card rates. This disappears. New text, How long is the Grace Period?

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Some cards start charging interest immediately, while others may give you weeks before you have to pay interest. Look for a summary of rates and fee disclosures. It should explain how to avoid paying interest. Use this information to make sure you choose the credit card that best matches your lifestyle and your spending habits.

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Text, Navy Federal Credit Union, Source, NCUA, This video 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, financial, or other advisor for specific information about your individual financial situation. Federally insured by NCUA

Audio Described Video

Credit vs. Debit

Credit and debit cards may swipe the same way, but you should know the differences between them. Credit cards are a form of borrowing, like a short-term loan, while debit cards are essentially an electronic check linking directly to your checking account. To understand how credit and debit cards compare, take a closer look at the chart below.

	Credit Card	Debit Card
Source of funds	Revolving credit line	Tied to your checking account; not a loan
Spending limit	Card issuer sets a credit limit based on your credit history; over-limit penalties may apply or your card may be declined if you spend more than the credit limit	Limited to the funds in the account; overdraft and insufficient funds fees may apply if you spend more than the balance in your account
Payments	Monthly minimum payment based on current balance	Funds are debited from your account almost immediately; no additional payments are needed
Interest rate	Dependent on each card’s rate; you won’t have to pay interest if your balance is paid in full each month	No interest charged
Fees	Could include annual fee, over-the-limit fee, late payment fee or bounced check fee	Overdraft fees may apply if you have opted into a service and complete a purchase that is more than your available checking account balance
Effect on credit history	Responsible use and timely payments can help to improve credit score; poor or no credit history may affect your ability to qualify for a credit card	Your credit history will only be affected if overdraft fees on your account are not paid and are handled by a collection agency

Effect on Credit

How you use a credit card affects your credit history, one aspect of your credit report. Your credit history can affect your ability to receive a loan, employment or a place to live, so it’s really important to create a credit history that reflects responsible and intelligent financial habits.

Here is what you can do to begin building a positive credit history:

Use your card regularly
Make your payments on time
Keep your balance below your limit
Continue to use your credit card over an extended period of time
Regularly read your credit report to make sure it’s error-free

When you practice these tips and responsibly use your credit card, you’ll improve your credit and may even get a higher credit limit. With a higher credit limit and the same responsible practices, you can maintain a low debt-to-credit-limit ratio and further improve your credit standing—which will give you the opportunity to finance large purchases, such as a home, at lower interest rates.

Borrowed Money

Revolving Credit

Credit vs. Debit

Effect on Credit

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