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How Does a Credit Card Work

written by: Dale DeVries•edited by: Laurie Patsalides•updated: 2/4/2009

Before you apply for a credit card there are many things to consider. You want the credit card that best fits your needs without paying many of the unwanted fees. There are ways to compare the terms and types of cards so you are sure that you are getting the best deal out there.

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    The Credit Card

    A credit card is a line of credit granted to you by an issuing bank in the form of a plastic card with an identifiable account number that enables you to shop without cash or obtain cash for emergencies for a fee. The front of the card has raised numbers which indicate what kind of credit card it is, the bank number, your account number and a check number. The expiration date and your name are also raised number. These numbers are raised because small retailers and many retailers in other countries use a credit card imprint machine to charge your card by running a bar over carbon copies of the receipt and then calling the bank for a verification number. Other retailers use the magnetic strip on the back of your card, which contains all of your information, and run it through a magnastrip reader which is actually a modem that contacts the bank and gives the retailer confirmation on the purchase. Your signature is also on the back of the card so the retailer can compare it to the signature on the receipt and verify that it is indeed the card owner signing the receipt. Readers can also be on your personal computer to purchase online but for the most part the information is still typed in by the individual making the purchase. The information on your purchases is then gathered by the bank and entered into a database under your account number. Normally once a month that information is then sent to you in the form of a statement and bill. Depending on the type of credit card you are using you will be asked to pay either the entire balance or a minimum monthly payment.

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    The Credit Card

    There are many things to consider when applying for a credit card. Most people tend to look at the interest rate first and this may not be the most important consideration for you. Research all of the options before deciding which card is best for you. Most commonly the best features on the credit card will be with the largest and best known banks. There are a few places online that do comparisons of credit cards but be careful they are not just pushing their own. Use a resource like U.S. Citizens for Fair Credit Terms that is unbiased. Make a list of the credit cards you’re looking at and compare the features and terms.

    Look at the annual fee if there is one. If the bank is stating no annual fee, check to see if that is just the year you open the account or there will never be an annual fee. Check the finance charges which is the cost of money you borrow. Normally a bank will charge a fee for a cash advance and attach a higher interest rate to it than your normal purchases. If you plan on paying the balance in full each month, see what their grace period is. You can go as long as 25 days in some cases without paying any interest on the money. The annual percentage rate is a calculation of the total interest rate and other fees included in the loan. It may be very similar to the interest rate or it could be much higher depending on the fees the bank charges. The interest rate is the rate the bank is charging you to use its money. This can be a fixed rate for a period of time or a variable rate that will change according to its terms. It may also be an introductory rate that is only good for a month to a year and then will change drastically. It is most important to read the fine print here and know exactly when the interest rate is going to change, if at all. You should also know that in almost every credit card contract today there is a clause that says if you are late on any payment, this may include another credit card, your mortgage or a car payment, that the issuing bank can raise your rate to the default rate which can be as high as 35%. Many credit cards offer reward such as cash back or frequent flyer miles. If this is important to you than paying a slightly higher interest rate may be in your best interest. The important thing is to compare the cards you’ve put on your list and pick the one that fits you the best.

    There are a few different types of credit cards for you to consider. The first is the bank card, sometimes referred to as a major credit card. These include Visa, Mastercard and Discover. They have programs for excellent credit, good credit and less than perfect credit. They also have plans for teenagers, college students and secured cards. This type of card covers the widest variety of plans for every need. Next are the travel and entertainment credit cards like American Express and Diners Club. These cards started out being charge cards where the balance had to be paid at the end of the month but there was no pre set spending limit. They still have those cards but they have also developed their own credit cards also. Lastly, there are the store cards. These credit cards are only good at the store they are issued for. You can also get this type of card for gas stations and phone companies. Only you can decide what type of card is right for you.

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    The Credit Card

    The issuing bank will report to the credit bureau how you use the card and this will affect your credit score. Be sure to pay it on time and try to never use more than half of your available credit unless you plan on paying it down as soon as you get the bill. Don't credit hop from one introductory offer to another as this will adversely affect you score. If you have had credit problems in the past that are keeping you from getting a credit card, consider a secured credit card instead. A secured card allows you to send money to the issuing bank as a security for your purchases. Your credit limit will be that of the deposit you have made with the bank. You can rebuild your credit by using this type of credit card wisely.