Credit cards are a part of many people’s daily lives. You can use them to make purchases and they can help you build credit and improve your credit score. While there’s no denying the convenience factor of credit cards, if you don’t use them responsibly, you could end up in debt. Understanding how credit cards work and what options are available to you will help you take control of your finances.
Credit cards are pieces of plastic or metal issued by financial institutions to approved consumers looking for a line of credit. Your credit card is assigned a credit limit, which is the maximum amount of money you can use to pay for goods or services. You’re essentially borrowing funds that will need to be paid back at a later date.
When your bill arrives, you can choose to pay the full balance, the minimum payment, or an amount in between. If you can pay off the entire balance, it’s a good idea to do so. That means you won’t owe anything else because of the interest-free grace period of at least 21 days on your purchases. However, if you decide to make the minimum payment or even a partial payment, you’ll incur interest charges. These extra fees can add up quickly and will increase the overall cost of your purchases.
Credit card providers will also report your credit history to one of the two credit bureaus: Equifax and TransUnion. If you make your payments on time, you can improve or maintain your credit score. Missing payments or maxing out your credit cards — spending all the way up to your credit limit — can negatively affect your credit score. Having a lower credit score might affect your ability to access additional credit, such as a car loan or mortgage, in the future.
» MORE: What’s a good credit score?
Although all credit cards work in similar ways, different types of cards offer various benefits and rewards. What kind of credit card you should pick depends on your needs, your credit, and other factors.
If you have a good credit score, rewards credit cards may be appealing as you’ll get something back for every purchase you make. However, make sure the rewards you earn outweigh any costs you pay for the card, like an annual fee. Generally speaking, there are four kinds of rewards cards to consider:
As the name implies, low-interest credit cards have low interest rates, often in the range of 9% to 13%. Their rates can be significantly lower than the typical credit card interest rate of 20%, which can be an advantage if you carry a balance on your credit card. Some low-interest credit cards offer a balance transfer option with a promotional rate. This type of promotion allows you to move your debt from an existing credit card to your new one at a lower interest rate for a fixed period.
If you don’t have a credit history or you’ve made mistakes that have lowered your credit score, you may not qualify for a traditional credit card. That doesn’t mean you won’t have access to credit cards; you’ll just be limited to the following choices:
Every credit card comes with some kind of cost or fee, but they’re not always obvious. Here’s what to look out for:
Technically speaking, you don’t need to have a credit card, but there are a few compelling reasons to get one:
A credit card is just one of the tools you’ll use on your money journey. If you always pay off your balance in full, you can reap the benefits without paying extra costs. However, if you overspend or fall behind on your monthly payments, you could quickly find yourself in a debt trap. Be smart about your money and use your credit cards responsibly.
» MORE: How to apply for a credit card
Barry Choi is a personal finance and travel expert. His website moneywehave.com is one of Canada's most trusted sites when it comes to all things related to money and travel. You can reach him on Twitter: @barrychoi.