How Do Credit Cards Work? | The Basics Made Simple
Is there one very best credit card somewhere out there? There certainly are a lot of very good cards, but it’s virtually impossible to pinpoint which one is the best.
The credit card industry has seriously evolved in the past couple of decades. They moved well beyond the scope of simply providing revolving lines of credit, and competing with one another over interest rates and credit limits. Today’s credit cards have become highly specialized, and most fall into a particular niche.
While a given credit card may do several things well, it’s usually one of those niches where they provide the biggest benefit.
If you’re searching for the best credit card, you’ll need to focus on finding the best credit card for you and your own personal needs and preferences.
We’re going to help you do that by introducing the basic credit card categories, as well as some of the top performers in each.
Table of Contents:
- Balance Transfer Credit Cards
- Credit Cards for People with Poor Credit
- Travel Rewards Credit Cards
- Cash Back Credit Cards
- Student Credit Cards
- How To Choose the Best Credit Card
Balance Transfer Credit Cards
If you already have a large amount of high interest credit card debt, you may be able to do a debt consolidation into a balance transfer credit card.
Those are cards that allow you to pay off other credit cards, while providing an extended period with a 0% introductory APR.
You pay nothing in interest during the term of the introductory offer, then any balance remaining at the end of the initial term is subject to ordinary interest.
Balance transfer credit cards are an excellent strategy to pay off or at least pay down debt. Since you don’t have to pay interest, you can direct additional payments into loan principal. That will get you out of debt faster.
Balance transfer cards can also save you a small fortune. Let’s say you have four credit cards with a combined outstanding balance of $10,000, and an average annual interest rate of 20%.
If you transfer those balances to a balance transfer credit card offering a 0% introductory APR for 18 months, you’ll save as much as $3,000 in interest expense over a year-and-a-half.
3 of the Best Balance Transfer Credit Cards
What to watch for: Balance transfer credit cards almost always charge a balance transfer fee. The fee can be between 3% and 5% of the amount transferred. On $10,000, that translates to $300 to $500.
- Citi Double Cash Card – 18 months
- Wells Fargo Platinum Visa Credit Card – 18 months
- BankAmericard Credit Card – 12 months
Credit Cards for People with Fair or Poor Credit
There was a time when you couldn’t get a credit card unless you had good or excellent credit. But the industry is now opening up to accommodate all credit levels, and it’s even possible to get a credit card with poor credit.
Naturally, the card options are more limited with impaired credit. Also, the terms offered with fair or poor credit cards are less generous. But the main purpose they serve is to enable you to have a credit card to use when necessary, as well is to provide a positive credit reference.
For example, credit cards for people with fair or poor credit typically report your payment history to all three credit bureaus. That will enable you to begin improving your credit scores, so that you can eventually get a more traditional credit card.
Though it may seem unconventional, banks and credit unions frequently offer credit cards for people with fair or poor credit. In most cases, you’ll be given a secured credit card.
For example, if you put $1,000 into a savings account, it can act as collateral for a credit card with a $1,000 credit limit. You can increase the credit limit by adding more money to the savings account.
A good example is the DCU Visa Platinum Secured Credit Card. It comes with no annual fee and a current interest rate between 11.50% and 18.00% APR, which is better than many traditional credit cards offer.
But the card comes with all the benefits of a Visa card, with the only difference being that it’s secured.
There are other cards available from various sources that issue unsecured credit cards.
One example is the Indigo Platinum Mastercard. They’ll issue you a credit card even if you have a recent bankruptcy.
But the card will have a very low credit limit, usually not more than $300. They also charge a very high annual fee, which can be as high as $99. What’s more, the annual fee will be deducted upfront, reducing your credit limit the $201.
What to watch for: If you get a credit card for fair or poor credit, it’s critical that you make all payments on time. The main purpose of such a card is to help you build good credit, to offset your bad credit entries, and raise your credit score. That can only happen if you’re absolutely religious about making your payments on time.
Travel Rewards Credit Cards
Travel rewards credit cards are a type of rewards credit card that are centered on travel. For example, they typically provide the highest rewards for travel-related purchases. A card may enable you to accumulate rewards at 3X each dollar spent on travel and dining, and 1X on all other purchases.
It usually works the same way with rewards redemptions. Travel rewards credit cards enable you to accumulate rewards by either points or miles. Either are typically redeemed for travel-related activities, like airfare, hotel stays, cruises, or vacation packages.
What to watch for: Travel rewards credit cards work best for frequent travelers. Even if the rewards package is attractive, you may not get many benefits if you’re not an active traveler. If so, you may be better suited to a cashback credit card, which won’t restrict your rewards redemptions primarily to travel.
3 of the Best Travel Rewards Credit Cards
- Chase Sapphire Preferred Card – Earn 60,000 bonus points, worth up to $750, after spending $4,000 in the first three months of opening your account.
- Venture From Capital One Rewards Credit Card – LTO! Earn 100,000 bonus miles, worth $1,000, after spending $20,000 on purchases within the first twelve months of opening your account, or still earn 50,000 miles if you spend $3,000 on purchases in the first 3 months.
- Bank of America Premium Rewards Credit Card – Earn 50,000 points, worth $500, after spending $3,000 within the first three months of opening the account.
Cash Back Credit Cards
Cash back credit cards tend to have the best rewards benefits for the largest number of consumers.
That’s because they pay rewards in cash or cash equivalents, giving you greater flexibility in using the benefits. In many cases, there are even options to redeem your cash back for certain travel benefits.
One of the major advantages of cash back credit cards is that they may give you a large number of redemption options. At a minimum, you’ll be able to apply your cash back rewards as a statement credit against your credit card balance.
But many cards also allow you to redeem your rewards for select purchases, cash back at ATM machines, funds transferred into a linked bank account, or even mailing you a check.
Like travel rewards credit cards, cash back credit cards usually offer generous sign-up bonuses. But the bigger advantage is ongoing cash back rewards on purchases. In the best cases, the cashback can amount to hundreds of dollars per year.
What to watch for: Credit cards paying higher cash back rewards on select categories will only be a benefit if you’re likely to spend heavily in that category. Also, be aware that many cash back cards put a dollar limit on how much you can spend in the higher rewards categories.
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3 of the Best Cash Back Credit Cards
- Blue Cash Preferred Card from American Express – Limited time high cash back offer- earn $300 back after you spend $3,000 on your new card in the first 6 months. Plus earn 6% cash back on up to $6,000 in grocery purchases, 3% at gas stations, and 1% on all other purchases.
- Bank of America Cash Rewards Credit Card – Earn 3% cash back on a category you choose, plus 2% at grocery stores and warehouse clubs, and 1% cash back on all other purchases.
- Chase Freedom – New Offer! – Earn a $200 bonus after you spend $500 on your new card in the first 3 months, plus earn 5% cash back on rotating categories, which change each quarter, and 1% cash back on all other purchases.
Student Credit Cards
This is an important category of credit cards because many young people a) need a credit card for living away at school, and b) it’s likely to be their first credit card. Since a young person is unlikely to have a credit history, it’s not easy to get that first card. The student credit cards have evolved to fill that niche. In many cases, a student with no credit history will be approved for a credit card with a small credit line. In other cases, they may require a co-signature from parents.
Student credit cards also offer rewards, similar to (though not as great as) more traditional credit cards. But while the rewards are certainly a welcome benefit, the bigger advantage is usually having standard credit card features, like travel, purchase protection and the ability to make online transactions. Some student credit cards even provide free credit scores.
What to watch for: Since a student credit card is usually the first credit card a young person gets, it’s important to use it responsibly from the very beginning. Many students get into trouble with credit cards due to lack of experience. That can put you in a position of graduating from college with fair or poor credit, which will make it difficult or more expensive to purchase a new car or get an apartment. A student credit card needs to be managed properly.
3 of the Top Student Credit Cards
- Discover it for Students – Earn 5% cash back on rotating quarterly categories, plus 1% on all other purchases. There is no annual fee, no foreign transaction fee, and no late fee on your first late payment.
- Wells Fargo Cash Back College Visa – Earn 3% cash back on groceries, gas and pharmacies for six months, plus 1% on all other purchases. There is no annual fee.
- Journey Student Rewards from Capital One – Pays 1% cash back on all purchases, but increases the rate to 1.25% each month you make an on-time payment. There is no annual fee and no foreign transaction fee.
Other Common Credit Card Benefits
With the above credit card types, we’ve focused on 0% introductory APRs on balance transfers, travel rewards, cash back rewards, and sign-up bonuses. But the typical credit card today has become a cornucopia of benefits, many of a non-financial or semi-financial nature.
Some examples include:
- Collision damage waiver on auto rentals, enabling you to decline auto insurance fees charged by car rental companies.
- $0 liability for unauthorized charges.
- 0% introductory APR on new purchases.
- Free credit scores.
- Advance access to major events, like concerts, sporting events, live shows and movies.
- Concierge services, offering assistance for travel, entertainment, dining and other activities.
There are many more. These benefits are not usually game changers when selecting a credit card. But if two cards are in the running, you’ll want to look closely at the secondary benefits and see which card offers the most and the best.
Typical Credit Card Fees
The most obvious expense with a credit card is interest, and all credit cards charge it. But there are a number of other fees to be aware of a connection with credit cards:
- Annual fees – many cards don’t charge them, but a typical fee is $95.
- Late fees or returned payment fees – these are typically in the $35 to $40 range per occurrence.
- Balance transfer and/or cash advance fees – these usually run between 3% and 5% of the amount of the transfer or advance, and are subject to a minimum of $5 or $10.
- Foreign transaction fees – typically 3% of the amount of the transaction, though many credit cards don’t have this fee at all (they shouldn’t be charged by travel rewards cards for obvious reasons).
Also, be aware the credit cards often have various interest rates. There’s the regular annual percentage rate (APR), but there’s usually a higher APR on cash advances, and a still higher penalty APR imposed if you make a late payment.
Do Interest Rates Matter Any More?
Once the gold standard in credit cards, interest rates don’t seem as important as they once were.
They certainly still matter, but few credit card companies make a big deal out of the rates they charge.
That’s probably at least in part because they can range anywhere from about 15% to 25% or more, which is much higher than other consumer interest rates, like mortgages and auto loans.
However, it seems most consumers are most heavily focused on the benefits provided by a credit card, like sign-up bonuses, 0% introductory offers, and ongoing rewards.
As well, the vast majority of credit cards charge interest in about the same range. And since you never know exactly what rate you’ll be charged until your card is approved, rewards, bonuses, and balance transfer offers tend to take center stage.
Choosing the Right Credit Card
If you’ve investigated credit card offers in the past, you know this can be a complicated process.
Though there’s usually one benefit that’s most important to you in selecting a card, each card represents a basket of benefits. You have to weigh out which card will offer the best package for you.
For example, while you may be most interested in a 0% introductory balance transfer offer, what happens when that offer expires? At that point, ongoing rewards benefits will become more important.
The basic idea then is to select a card that combines both a long-term introductory offer on balance transfers and attractive rewards.
One potential distraction, however, is the annual fee. Consumers will often give it more weight than it actually deserves.
For example, it’s likely that a card that has a $95 annual fee and 2% cash back will be a better deal in the long run than a no-fee card that pays 1% cash back.
This is why it’s so important to look at all the details in selecting the right credit card. And as stated earlier, make sure that the rewards categories offered by a card most closely match your own spending patterns.
The benefit will be watered down substantially if you’re having to change your spending habits to conform with a credit card’s rewards program.
How to Get the Most Benefit Out of Your Credit Card
We just pointed out that interest rates don’t seem to matter with credit cards, at least not nearly as much as they once did. In reality, they do matter. After all, the interest rate charged by a credit card represents the biggest single ongoing expense of having that card.
With today’s focus on rewards and benefits, concern for interest rates has certainly waned. But if you truly want to get the most benefit out of a credit card, it’s best to pay off your balance in full each month.?
For example, let’s say you have a credit card that provides an average of 2% cash back on purchases. If the card also has an interest rate of 23.99%, you’re losing your cash back to interest.
You can look at that as a positive – that the cash back is offsetting the interest, effectively giving you an interest-free loan. But the cashback is a one-time benefit, while the interest charge on the card is ongoing.
The best way to get the most benefit out of a credit card then, especially a generous rewards card, is to pay off your balance in full each month. If you do, you won’t be paying interest each month, and you’ll get the full benefit of the rewards.
Do that, and interest rates truly won’t matter.
As you can see, choosing the right credit card is a pretty complicated process. Once again, look for the card that offers the best combination of benefits for you.
But also be aware that the credit card industry has become incredibly dynamic in recent years. Today, one credit card may stand out as better than the others. But a year from now, another card may come along with a better package.
Also, be aware that all credit cards come with a healthy helping of fine print. Buried in that fine print is the credit card giving itself the legal authority to changes benefits structure at any time and with minimal notice. Just because a card is top-notch today, doesn’t mean that’s permanent!
Credit card industry has become amazingly dynamic – and competitive. For that reason, you should stay on top of developments on a regular basis, both with any credit cards you have now, and with new ones coming out.
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