A BEGINNER’S GUIDE TO CREDIT CARDS

How credit cards work

The idea behind credit cards is simple: When you use a credit card, you are borrowing money to pay for something. Later on, you must repay what your borrowed. If you take time to pay it back (rather than pay it in full when your credit card statement comes), you’ll be charged interest. The whole credit cards industry rests on this basic premise.

A basic credit card transaction works like this:

1. You swipe your card. When it comes time to pay for something, you use your card at the cash register by running it through a card reader (or, if you’re online, you enter your card information on the checkout page).

2. The purchase is authorized. The card reader contacts your credit card company to make sure the card is valid for the purchase amount. Assuming everything is OK, the transaction is authorized.

3. The merchant gets paid. The bank that issued your credit card sends money for the purchase to the merchant where the transaction took place.

4. You pay. The transaction shows up on your credit card statement, and you repay the bank for the purchase.

How credit card rewards work

Types of rewards

Many of the best credit cards give you rewards for your spending. Rewards come in two basic flavors:

• Cash back. You can use cash back to directly reduce your balance. In some cases, you can have your cash back deposited in a bank account or sent to you as a check.

• Points or miles. Points and miles can be redeemed for travel, gift cards, merchandise or other things. You may also have the option of redeeming points for credit on your statement, just like cash back.

The card issuer sets the rewards rate that applies on your card. There are two basic kinds of rewards structures:

• Flat rate. You get the same rewards rate on all spending done with the card, regardless of what you spend money on. You might get 2 points per dollar on all purchases, or 1.5% cash back on everything.

• Bonus rewards. You earn a base rate on all spending (typically 1 point per dollar or 1% cash back) and then higher rates in certain categories — 5% cash back at gas stations, for example, or 3 points per dollar spent on travel. Bonus rewards are awarded based on where you buy something, not what you buy. Every merchant is assigned a category code; if your card pays bonus rewards at grocery stores, for instance, you’ll earn those rewards any time you pay at a merchant with a category code that identifies it as a supermarket or grocery store.

Many credit card users carry multiple cards with bonus rewards in different categories, plus a flat-rate card for purchases that fall outside those categories.

Tracking your rewards

The rewards you earn on your card are stored in a rewards account that you can access when you log into your card account online or, often, from the issuer’s mobile app. Some issuers credit your rewards account for a purchase almost immediately. In other cases, your rewards account will update when your billing cycle closes and the issuer prepares your credit card statement, so it can take several weeks for rewards from any particular purchase to show up in your account.

The rewards process

The rewards process works like this:

1. You make a purchase with your credit card.

2. The issuer calculates your rewards. If you have a card that earns bonus rewards, the issuer looks at the category code of the merchant where you made your purchase and then applies bonus rewards as necessary. Otherwise, the issuer just calculates your rewards based on the flat rate.

3. The issuer credits your rewards to your account. As mentioned, it could take anywhere from a few days to a few weeks for the rewards to show up.

4. You redeem rewards by logging into your account online. Cash-back redemptions are pretty straightforward. Redeeming points or miles might involve booking travel through an online tool similar to Orbitz or Expedia. Every card is different.

How credit card interest works

When you borrow money from a bank, you usually have to pay interest, which is the cost to you of using the bank’s money. Credit cards are unusual in that there is a way to avoid interest entirely. Most cards offer a “grace period”: If you pay your balance in full on each statement — meaning you don’t roll over any debt from one month to the next — you won’t be charged interest. If you carry debt, though, you’ll be charged interest. Interest works like this:

1. Your card issuer sets your interest rate. In general, the better your credit, the more likely you are to qualify for lower rates, but credit card interest rates tend to be significantly higher than rates on other consumer debt.

2. Your interest rate is listed on your credit card statement. It’s expressed as an annual rate, but in most cases it is charged on a daily basis. So if your interest rate is 17.5% a year, it’s actually charged at about 0.048% per day.

3. When your billing cycle ends, your issuer calculates how much interest you owe. Your interest charge is based on your daily balances and your daily rate.

4. The interest charge is included in your next month’s minimum payment. Credit card interest generally does not compound — meaning, it does not get added into your balance. You have to pay your full interest cost each month.

DIFFERENT TYPES OF CREDIT CARDS

Credit card companies offer different kinds of cards to meet different consumer needs. Some people put a lot of money on their cards every month and then pay them off immediately; those people benefit from a card that returns a portion of their spending in the form of rewards. Others tend to carry a balance from month to month; they’re better served with a card that offers a low ongoing interest rate. Still others are working to improve their credit; issuers have cards designed for those people, too.

Here are the major types of credit cards.

Rewards credit cards

These cards “pay you back” for a portion of your spending by giving you cash, points or miles. See our roundup of the best rewards credit cards for a range of options for different types of users. Or look into specific types of rewards cards:

• Cash-back credit cards give you, well, cash, which you can use to reduce your balance or, in some cases, have deposited in a bank account or sent to you as a check. See our best cash-back credit cards.

• General travel credit cards give you points that you can use to pay for travel. Unlike cards tied to specific airline or hotel loyalty programs, these cards offer a great deal of flexibility. You can use their rewards on airlines, hotels and other expenses. See our best travel credit cards.

• Airline credit cards carry the name of a specific airline. When you use them, you earn miles that you can redeem for free flights or upgrades on that airline. These cards don’t offer a lot of flexibility in terms of how you can use your rewards, but they really pack in value with exclusive perks — free checked bags, priority boarding, airport lounge access and more. See our best airline credit cards.

• Hotel credit cards carry the name of a specific hotel group, and they earn points that you can redeem for hotel stays. As with airline cards, the perks can be fantastic — a free night every year, automatic upgrades, elite status and so on. See our best hotel credit cards.

Balance transfer credit cards

These allow you to move debt from a high-interest card onto a new card and then give you a year or more at 0% interest to pay that debt off. You’ll often pay a fee for the transfer, but the interest savings can be substantial. See our best balance transfer credit cards.

Low-interest and 0% credit cards

These cards are best for those who expect to carry debt from month to month. Zero-percent cards offer new cardholders a year or more of 0% interest on purchases, making them suitable for a big expense. Low-interest cards might not offer a 0% period, but they have a low ongoing rate that makes them a good long-term option. See our best low-interest and 0% credit cards.

College student credit cards

These cards are designed specifically for college students who are just getting started with credit. The application process takes into account the fact that young people are unlikely to have a long credit history or a high-paying job. Be aware, though, that simply being a college student is not enough on its own to qualify. See our best college student credit cards.

Small business credit cards

These cards are designed for entrepreneurs and small-business owners. Their rewards and perks are tailored toward businesses, and they offer perks like free cards for employees and tools to track expenses. They’re a step below corporate cards, though; when you apply, the issuer takes your personal credit history into account. See our best small business credit cards.

Credit cards for building credit

The credit cards with the richest rewards, plushest perks, lowest interest rates and longest 0% periods are available only to those with good to excellent credit. If you’re still building your credit (or rebuilding it after a misstep), you’ll want to hold off on applying for these cards until your score improves. However, banks have designed cards specifically for people working to improve their credit. Getting one of these cards and using it responsibly can go a long way toward your goals:

• Credit cards for fair credit are intended for those with credit scores roughly in the range of 630-689, sometimes also referred to as “average” credit. See our best credit cards for fair credit.

• Credit cards for bad credit are intended for people with scores of less than 630. The best credit cards for bad credit are secured cards, which require you to put down a cash deposit (which is refunded to you if you upgrade or close the card in good standing). There are “unsecured” cards for bad credit that don’t require a deposit, but they tend to charge high fees. See our best credit cards for bad credit.

• Secured credit cards, as mentioned above, require a refundable security deposit, which is usually equal to your credit limit. (The more you deposit, the higher your credit limit.) The deposit protects the issuer in case the cardholder doesn’t pay their bill, so these cards are usually easier for people with lower credit scores to qualify for. Be aware that some secured cards are available to people with no credit or a thin credit history but not to people with damaged credit. See our best secured credit cards.

CHOOSING A CREDIT CARD

If you’re a beginner to credit cards, see our step-by-step guide to choosing a credit card. It starts by helping you figure out what cards you can qualify for, then walks you through deciding what kind of card best fits your needs. The process in short:

1. Check your credit. The higher your credit score, the more likely you are to qualify for the best cards.

2. Decide on a broad card type. If your credit score needs work, get a card designed for building or mending credit. Otherwise, choose between a card that will give you rewards for your spending or one that will save you money on interest.

3. Narrow your choices. If you want a rewards card, do you prefer cash back or points, and how much effort are you willing to put into managing your rewards? If you’re looking to save money on interest, do you need a 0% introductory period, or a low ongoing rate? Do you need to do a balance transfer? Are you a student or a business owner who could benefit from a specialized card?

4. Apply for a card that gives you the best overall value.

Comparing credit card features

Every credit card delivers value in its own way, through its own unique combination of features. And there are trade-offs involved. If you want rewards, for example, you’ll probably have to accept a higher interest rate. If you want high-value perks, you’ll likely pay an annual fee. If you want a low interest rate and no fees, you shouldn’t expect much else from the card. In other words, you’re unlikely to find a single card that offers a high rewards rate, a long 0% period, a rock-bottom ongoing interest rate, generous perks and no annual fee.

Here are the main points of comparison when looking at credit cards.

Annual fee

Some people are dead-set against paying a fee just for the privilege of carrying a credit card. But paying an annual fee is worth it in certain circumstances. For example:

• To earn significantly better rewards rates.

• To unlock valuable perks, such as airport lounge access or free checked bags.

• To get a card when you might not otherwise be able to, such as by avoiding a credit check.

With any annual fee, the math comes down to whether the value you get from the card exceeds the dollar amount you pay. Still determined not to pay? See our best credit cards with no annual fee.

Other fees

Depending on what you plan to do with the card, you’ll want to take these other fees into account:

• Balance transfer fee. This is a charge you pay to move debt from one card to another. Fees are typically 3% to 5% of the amount transferred, but some cards don’t charge a transfer fee, or they waive it for a time. See our best credit cards with no balance transfer fee.

• Foreign transaction fee. Most cards charge a fee of up to 3% on purchases made outside the U.S. If you travel internationally, getting a card that doesn’t charge this fee is a must. See our best credit cards with no foreign transaction fee.

• Cash advance fee. Using your credit card to get cash is expensive. You’ll usually pay an upfront fee, the interest rate for cash advances is often higher than for purchases, and in many cases, grace periods don’t apply to cash advances, so you start paying interest on them immediately. A few cards don’t charge a fee for cash advances. Some cards don’t allow advances at all.

• Late fees and returned-payment fees. These fees can be steep, but they are avoidable. Most cards charge them, but some do not.

Introductory interest rate

Credit card companies drum up business by offering people with good credit a low introductory interest rate. A bunch of cards offer 0% on purchases and balance transfers for a year or more. Some cards don’t go as low as 0% but still offer a lower introductory rate.

Ongoing interest rate

The ongoing rate is what you pay after any introductory rate expires. Some cards charge a single rate for all cardholders; others allow for a range of rates depending on your creditworthiness. In general, the better your credit, the more likely you are to qualify for a low rate. That said, if you pay your balance in full every month, your interest rate doesn’t actually matter because you’re never charged interest.

Ongoing credit card interest rates are usually identified as “variable.” That means they can change under certain conditions. Most rates are tied to the prime rate, which is the rate that big banks charge their best customers. Typically, a credit card rate is set as the prime rate plus a certain number of percentage points, so if your rate is “prime + 6” and the prime rate is 6%, then your rate would be 12%. When the prime rate goes up (or down), so will your card’s rate.

What’s the lowest interest rate on any credit card?

Although introductory interest rates of 0% are common, you’re not going to find an ongoing rate lower than the prime rate. Still, some cards offer a rate just a few points above prime. For super-low ongoing rates, your best bet is a credit union.

Rewards

Cash-back cards refund a certain percentage of the purchase price. Other cards give you a certain number of points or miles per dollar spent. Every card sets its own rewards structure, so apples-to-apples comparisons can be difficult. But when comparing rewards programs, think in terms of:

• Earn rate. What do you get for every dollar spent?

• Redemption value. How much do you get for your rewards when it comes time to use them?

• Redemption options. How much flexibility do you have in using your rewards?

SIGN-UP BONUS

The sign-up bonus or welcome offer is a sum of cash (say, $150 or $200) or a batch of points or miles (say, 40,000 points or 50,000 miles) that you can earn by spending a certain amount of money in your first few months with a card. The purpose is to get you in the habit of using the card. The bonuses on many travel cards are often big enough to cover the card’s annual fee for the first few years. See our best credit card sign-up bonuses.

Perks

Unlike rewards, which are what you receive for using a credit card, perks are benefits you get just for carrying a card. With some cards, particularly travel credit cards, it may be the perks that provide the bulk of the value. Premium credit cards, which have annual fees of $450 and up, tend to offer the cushiest perks. Airline credit cards and hotel credit cards can easily pay for their annual fee with their perks. A full list of potential perks would be too long to include here, but common examples include:

• Airline/airport benefits. Lounge access. Free checked bags. Priority boarding. Elite status.

• Hotel benefits. Free nights. Automatic room upgrades. Early check-in/late check-out. Free amenities. Elite status.

• Statement credits. Automatic credit for such things as travel expenses, purchases from selected merchants or the application fee for trusted-traveler programs.

• Purchase protections. Extended warranties. Protection in case of theft or damage. Price protection (which refunds the difference if you find the same item cheaper elsewhere). Return guarantees.

• Rental car coverage. Supplemental coverage on top of your own auto insurance policy, or even primary coverage in place of your own policy.

• Cell phone insurance. Coverage in case of loss or damage. You usually have to pay for your service with your card to qualify.

• Credit tracking and security. Free credit score. Credit monitoring services. Ability to “lock” your card.

Credit-building help

When you’re looking to build or restore credit, several features are more important for you than for people who already have good credit.

• Reporting to credit bureaus. If you’re using your card responsibly, you want your credit score to reflect that. Make sure that your card reports payment activity to all three credit bureaus, the companies that assemble credit reports.

• Deposit requirements. If you’re getting a secured credit card, you’ll need money for a security deposit. Minimum deposits are usually in the $200 to $300 range.

• Upgrade opportunities. As your credit improves, it’s nice to be able to upgrade your account to a better card.

• Incentives for responsible behavior. Some cards might boost your rewards rate if you pay on time, or give you access to a higher credit line.

How the application process works

When you put in an application for a credit card, the card issuer makes its decision based on how risky it believes it would be to lend money to you. The issuer doesn’t know you, of course, so it goes by information you provide (about your employment, income and assets) and information contained in your credit report.

The basic application process works like this:

1. You fill out an application for a card. Nowadays, this is usually done online, but paper application forms still exist. The application typically asks for:

   • Your name, address, phone number and email address.

   • Financial information, including your employment status and annual income. The application may also ask about your assets (such as bank accounts or investments) and your other obligations, such as your rent or debt payments.

   • Your birthdate and Social Security number. The issuer needs these to access your credit report.

2. The issuer checks your credit. Many people think of their credit only in terms of their credit score. But that three-digit number is really nothing but a summary of the information in your credit report. It’s the report that issuers are interested in. You could have a great score but still be rejected for a credit card because the issuer thinks you’ve applied for too many new cards in the recent past, or because your debt obligations are too big relative to your income.

3. If you meet the issuer’s requirements, your application is approved. With online applications, approvals are usually possible within minutes. (If your application is rejected, you can usually expect to receive a written explanation by mail in about a week to 10 days.)

4. Your new card comes in the mail. This typically happens within 10 business days.

5. You activate your card. Do this by calling a phone number or going online. Once it’s activated, you can use it.

What’s the easiest card to get approved for?

Approval for a credit card is never guaranteed. Even if you have an excellent credit score, an issuer could still decline your application because you don’t have enough income, or because you’ve opened several other cards recently, or for some other reason. Plus, “easy” is a relative term. Someone with excellent credit and a good income will usually qualify for most cards. Someone with a middling credit score might struggle to get approved even with ample income.

With that in mind:

• In general, the lower the risk to the credit card issuer, the easier it is to get approved. That’s why secured credit cards are a recommended starting point for people working to build or mend credit: The security deposit requirement reduces the risk. See our best secured credit cards.

• If you’ve begun to build credit and have a score in the mid-600s, look at credit cards for fair credit. These provide more benefits but don’t require a top-tier credit score. See our best credit cards for fair credit.

• Store credit cards are also generally easier to qualify for than bank cards. They tend to have low credit limits and high interest rates, but they’re a viable credit-building tool provided you keep your balances low relative to the limit and pay them off each month.

How many credit cards should you have?

Just as there is no single best credit card for everyone, there is no perfect number of credit cards to have. It depends on your needs and how much effort you want to put into managing your credit cards. Some people carry one card and put everything on it. Others have literally dozens of cards, and for each purchase they use the card best suited for that transaction. When deciding how many is right for you, keep in mind:

• There’s no limit to how many cards you can have. Each lender evaluates your credit on its own term, but there’s no hard limit where you have “too many cards.”

• You don’t need to have multiple cards to maintain good credit score. Credit scoring formulas tend to reward you for having different types of accounts — credit cards, mortgages, loans, etc. — but it’s not necessary to have multiple accounts of each type. One credit card, responsibly managed, is enough.

Advantages of carrying multiple cards

• Maximizing rewards: One card may pay you a higher rewards rate on groceries. Another may reward you handsomely at restaurants, or on gas purchases, or for spending on travel. Having multiple cards allows you to maximize your total rewards.

• Flexibility: Some cards are more widely accepted than others. It’s good to have a backup in situations where one card isn’t accepted. Additionally, if a card is lost, stolen or compromised, you’ll have another option while you wait for a replacement.

• More available credit: A key factor in your credit score is your credit utilization, or how much of your available credit you’re using. Ideally, you’ll want to keep utilization below 30%. If you have a $500 balance on a card with a $1,000 limit, your utilization is 50%. If you have $500 in balances spread across three cards with limits of $1,000 each, your utilization about is 17%.

RISKS OF CARRYING MULTIPLE CARDS

• Losing track of spending: The more cards you have, the harder it is to remember how much you’ve spent on which card.

• Missing a payment: Multiple due dates increase the risk of missing a payment, which can trigger a late fee or (if it’s late enough) even damage your credit.

CREDIT CARD COMPANIES

Credit card issuers, networks and co-brands

As you search for the best credit card for your needs, it will help to familiarize yourself with the different types of companies in the industry. That way, you’ll know not only what to look for in a credit card but also where to look for it. Every credit card has an issuer and a network. Many of them also have co-brand partners. Each of these provides different kinds of benefits.

Issuer

The issuer is the bank that maintains your credit card account. It could be a huge bank like Chase, Capital One or Wells Fargo, or it could be your local bank or credit union.

• The issuer takes your credit card application and decides whether you qualify for the card. It sets your interest rate and charges any account fees.

• The issuer sends your statement every month and collects your payments.

• When you make a purchase on a credit card, you’re borrowing money from the issuer, and when you pay off your card, you’re paying back the issuer.

• Benefits that come from the issuer: Rewards for your spending — cash back, points or miles per dollar spent — are typically paid to you by the issuer. The issuer may also provide perks (benefits you receive just for carrying the card, regardless of whether you use it).

Network

The payment network acts as a go-between for credit card transactions. Visa, Mastercard, American Express and Discover are payment networks.

• The network determines where you can use your card.

• When you pay for something with a credit card, the network makes sure that the transaction gets reported back to the issuer (so it shows up on your statement) and that the merchant gets paid (by your issuer).

• American Express and Discover are special in that they are both issuers and networks.

• Benefits that come from the network: Network-provided benefits tend to be protections and perks, like rental car coverage or travel insurance. In some cases, networks make certain benefits available on their cards, but it’s up to the issuer to decide whether a card will actually include them.

Co-brand partner

The partner is a store, airline, hotel or other brand whose name appears on the card and whose loyalty rewards program is tied to the card.

• Not all credit cards have co-brand partners.

• The partner administers the loyalty program linked to the card. For example, if you have an American Airlines credit card, you earn miles with your purchases. American operates the frequent-flyer program where you would use those miles.

• Benefits that come from the co-brand partner: The co-brand partner lets you redeem the rewards earned on the card and often provides additional perks to cardholders, such as free checked bags for an airline card, automatic room upgrades for a hotel card or discounts for a store card.

You can see how it works by taking a look at a few popular credit cards:

What’s the difference between Visa and Mastercard?

This is one of the most common questions about credit card companies. Just about every place that takes credit cards takes both Visa and Mastercard, with only a couple of exceptions (such as Visa-only Costco), so consumers are left wondering whether there’s a difference at all.

The most important thing to remember is that neither Visa nor Mastercard issues credit cards. These companies are just payment networks that process transactions. Most of the benefits that come with a card are provided by the card issuer, not the network. And since their acceptance rates are nearly identical, you’re better off focusing on the features of individual cards rather than which network they operate on. Read more about Visa vs. Mastercard.

What’s the best credit card company?

Just as there is no single best credit card for everyone, consumers have widely different opinions about the best (and worst) credit card issuers. One person could get the runaround from customer service rep and rate a bank zero stars as a result, while another has nothing but positive experiences and gives it five stars across the board. Still, some trends emerge in customer satisfaction surveys.

J.D. Power conducts an annual study of satisfaction among major issuers. It regularly rates Discover and American Express at the top among mass-market issuers, with several big banks not too far behind. In the most recent study, USAA had the highest rating of all, but keep in mind that only people affiliated with the military are eligible for USAA products.