What Is a Credit Card?

DEFINITION:

A credit card is a compact plastic or metal card issued by a financial firm. It lets you to make purchases by borrowing money up to a specified limit.

Key Takeaways

  • A credit card is provided by a financial firm and enables you to make purchases by borrowing money up to a specified limit.
  • To make a transaction in person, you must slide the card into a card reader. To make an online purchase, you must submit all your card details and your billing address. 
  • Once you pay off what you've borrowed, you may borrow again up to your credit limit. 
  • You may generally prevent interest costs by paying your bill amount on your due date. 
  • Though they seem the same, debit cards operate differently. They let you to make purchases by electronically deducting money from your checking account. 

Definition and Examples of a Credit Card

A credit card permits you to access a credit limit that's offered by your credit card provider. Your credit limit is the maximum amount you may borrow. Instead of providing you the whole loan in cash, the card issuer lets you take as much of the credit limit as you wish at a particular moment. As you make the minimum monthly payment needed by the issuer, you may continue to borrow as long as you do not hit the credit limit.

One example of a credit card is the Chase Sapphire Preferred credit card. It gives cardholders benefits in the form of points that can be used for items like airline miles and more.

How Do Credit Cards Work?

To make a purchase at a brick-and-mortar business, you normally place the credit card into a card reader so it can scan the security chip on the card. You may also be required to provide your billing ZIP code. At an online store, you'll be prompted to input the card number, expiry date, and security code (usually located on the back of the card), and your name and billing address.

When you swipe your credit card to make a transaction, the merchant's credit card terminal asks your credit card issuer if the card is legitimate and has enough available credit.

Your credit card provider then sends back a message saying whether the transaction is accepted or refused. If it's authorized, you're good to go. If not, you may have reached your credit card limit, or your card may have been deactivated due to suspected fraudulent activity. That doesn't always indicate your identity has been stolen; card providers may cancel your card and get in contact if you've made unexpected transactions.

Note

If you go overseas, your card issuer may deactivate your card until it certifies that you're the one who made the transactions.

How Your Credit Line Works

Each time you make a transaction, your available credit goes reduced by that amount. If you have a $300 credit limit, and you make a $25 transaction, you would have $275 in available credit. You'll owe $25 to the credit card company. If you borrow another $50 before paying back the $25 you borrowed, you would owe the bank a total of $75 and have $225 in accessible credit.

What makes a credit card distinct from a typical loan is that your credit limit is accessible after you pay down the debt. Assuming you began with a zero debt, if you were to pay back the $75 that you owed by your credit card due date, you'd have $300 of available credit again.

You may repeat the procedure of spending up to your credit limit and repaying the debt as often as you wish, providing you adhere by the rules of the credit card.

You may continue borrowing against your credit limit over time, which is why credit cards are referred to as "revolving accounts" or "open-ended accounts."

How Credit Card Interest Works

The credit card provider allows you a specific length of time to pay back the total amount that you’ve borrowed before you'll be charged interest. The amount of time before the interest is levied is termed the "grace period," which is normally roughly 21 days.

If you don’t pay off your whole debt before the end of the grace period, a fee or finance charge is charged to your balance. The financing fee is depending on your interest rate and outstanding amount.

The interest rate is the yearly rate you pay for borrowing money on your credit card. Interest rates are typically dependent on market interest rates, your credit history, and the sort of credit card you hold.

How Credit Card Minimum Payments Work

To avoid incurring interest, you normally have to pay your bill amount in full on or before your due date. However, the credit card issuer normally doesn’t compel you to pay back all of what you owe at once. You must pay at least the minimum payment before the due date to avoid a late penalty. Credit card issuers differ when it comes to how they decide your minimum amount, but you may find it in your credit card conditions.

It's crucial to always pay at least the minimum amount on time each month to preserve a clean credit history and prevent late penalties.

Note

Paying just the minimum is the slowest and most costly approach to pay down your credit card amount. It's important to pay as much as you can and, preferably, pay the remainder in full.

Credit Cards vs. Debit Cards

While credit cards and debit cards seem similar, they work in completely different ways. With a credit card, you're borrowing money from the credit card company. With a debit card, you're utilizing money from your checking account to pay for goods. To use a debit card, you also need to enter your PIN.

You may also use a debit card to withdraw cash out of your checking account at an ATM or when you make a transaction. Some credit cards enable you to obtain cash by getting a cash advance, but these transactions tend to have higher interest rates than purchases do, and they may not have a grace period. In other words, you must pay interest on the advance.

Credit Card Debit Card
Allows you to borrow against a credit line. Allows you to deduct purchases from your checking account electronically.
You may have to enter your billing ZIP code to make a purchase. You may have to enter your PIN to make a purchase.
You may be able to withdraw cash by making a cash advance. You can use it to withdraw cash from your checking account.