Using a Credit Card

When you use a credit card to pay for things you want or need, you borrow against a credit limit, which is the maximum amount you're entitled to borrow. When you pay back what you owe, you're able to borrow an amount up to the credit limit again. This is an arrangement known as revolving credit.

Overview

For example, if your credit limit is $1,500 and you charge $500 on your card to pay for an emergency car repair, you now have $1,000 available from which you can borrow. Once you pay back the $500, your full credit limit is available and you can borrow up to $1,500 again.

Though this arrangement is convenient, there are costs associated with it. One example is the interest charge, which is a percentage of your unpaid balance that is added to your bill every month for as long as you take to pay back what you borrowed. For example, if you have a balance of $500 on a card with an annual interest rate of 18%, your monthly interest charge will be $7.50. To calculate your monthly interest charge, multiply the rate that applies for one month, 1.5% in this example, times your unpaid balance.

The rates lenders charge on their credit cards differ, so it's important to look at a number of cards before settling on one. The easiest way to compare cards is to compare their annual percentage rates (APRs), which is the actual annual rate you'll be charged. All card issuers are required by law to disclose this figure.

The APR, however, isn't the only charge for which you may be responsible. There may also be an annual fee, though it depends on the card you choose. To ensure you choose the card that will cost you the least, be sure to research all the fees fully before making a selection.

A card's grace period also has a big impact on the amount you pay. The grace period is the number of days the creditor allows before it starts charging interest on the amount of any purchases you've made in the billing period. Often you must pay the previous statement balance in full to get a grace period, but if you have, and you pay your new balance in full before the grace period ends, you won't owe any interest. On the other hand, some cards don't have a grace period at all, which means you'll begin to accrue interest as soon as you buy something.

If you're just beginning to use credit, or are trying to improve your credit history, you might consider a secured credit card. This type of card is linked to a savings account that acts as collateral if you don't pay your bill. If you miss a payment, your creditor can take what you owe from the savings account. Be sure to understand the details before you commit yourself, however, as some secured cards charge very high fees and may cost you more than you expect.


Other types of cards

Charge cards are another type of card. A charge card doesn't typically have a set credit or spending limit, but you must pay your balance in full by the end of each billing period, so they aren't for everyone. Examples include certain American Express and Diners Club cards.

Tip

Keep in mind there may be various APRs for each card, one that applies to balances you transferred from other credit cards, one that applies to purchases, one that applies during an introductory period and so on. Be sure you understand all the APRs associated with any cards you are comparing, and especially the one you select.