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How Do Credit Cards Work

In a nutshell, credit cards allow you to charge purchases so you don’t have to spend cash up front. In exchange for that convenience, the credit card issuer charges interest when you repay what you’ve charged on the card, if you don’t pay the balance in full as dictated by the billing statement. More on billing in a moment.

Credit cards come with a spending cap (called a credit limit) which will vary by person. Your credit limit depends in large part on your credit score, credit history, and income level, plus your debt-to-income ratio which is an indication of your ability to repay.

When you apply for a credit card, the lender will determine your credit limit and offer you a card for that pre-determined amount. They will also present the APR (annual percentage rate) that you will be charged. Every time you use your card, you can technically spend up to the credit limit. And you will be given roughly one month (the average duration of a billing cycle) to pay the lender for the charges incurred. If you pay the balance IN FULL each billing cycle, you can avoid interest charges. But if that’s not possible, and let’s face it, that may not always be the case, then you will be charged interest according to the APR you agreed to in the credit card terms.

The billing cycle will also vary from person to person. The cycle can start on any day of the month. It could be the 1st of the month or the 10th or 23rd. You get the idea. It depends on when the card was issued and when activity is initiated on the card. Your credit card statement will include an Opening/Closing Date which is the activity period for that billing cycle. Any transactions or charges you made during this period will be reflected on your statement. Payment is due 27 days after the Closing Date. If you have questions about the billing cycle, interest charges, calculating payments, etc. we strongly encourage you to talk to your lender. It’s also a great way to learn based on your specifics as you start using the card.

The final thing to understand is the difference between purchases and cash advances. Purchases, as the name implies, refers to items you bought at a retailer, or charges you made online including paying bills. On the other hand, cash advances refer to essentially using your credit card like an ATM card to access cash. But be careful. Using your credit card as a debit card means much higher rates; often as much as 10 percentage points higher than the APR you would normally pay for purchases. This has tripped up a lot of people in the past, as there is often an assumption that the APR is the same, regardless of how you use the card. Your credit card issuer is required to outline the difference in terms, so be sure to read the fine print on your credit card offer and your billing statement.