{"id":58570,"date":"2023-02-27T01:45:58","date_gmt":"2023-02-27T05:45:58","guid":{"rendered":"https:\/\/www.iwillteachyoutoberich.com\/?p=58570"},"modified":"2025-04-04T11:32:06","modified_gmt":"2025-04-04T15:32:06","slug":"how-credit-cards-work","status":"publish","type":"post","link":"https:\/\/www.iwillteachyoutoberich.com\/how-credit-cards-work\/","title":{"rendered":"How Credit Cards Work (+ how credit card companies make money)"},"content":{"rendered":"\t\t
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Aren\u2019t credit cards bad? Don\u2019t they trap people in a ton of debt? Not quite. Credit cards are a tool. When used the right way, they can help you build wealth. If used irresponsibly, they can trap folks in a cycle of debt that\u2019s very difficult to break. Here’s how credit cards work.<\/p>\n

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Let\u2019s go through them, top to bottom.<\/p>\t\t\t\t\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t

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Credit Card Terminology<\/h2>\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t
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Here’s a quick list of some of the most common terms.<\/p>\n

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Annual Fee<\/h3>\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t
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Some, but not all, credit cards come with an\u00a0annual fee.<\/a>\u00a0This is exactly what it sounds like. You pay a yearly fee just for having the card. Usually, the fee is waived for the first year that you have the card. The fees range from $30 to $500 per year.<\/p>\t\t\t\t\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t

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Annual Percentage Rage<\/h3>\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t
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You\u2019ll usually see this abbreviated as APR. This is the interest rate you pay on the purchases you make. You can avoid paying interest if you pay off your full credit card balance each month.\u00a0<\/p>\t\t\t\t\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t

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Card Member Agreement<\/h3>\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t
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Your card member agreement lists all the card\u2019s terms and conditions. It\u2019s very important to read the fine print on the card member agreement before you apply, as some cards contain \u201chidden\u201d fees that aren\u2019t always immediately apparent on the card issuer\u2019s website.<\/p>\t\t\t\t\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t

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Credit Limit<\/h3>\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t
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Sometimes called a credit line, this is how much you can charge on the card. For example, if your card has a $5,000 limit, you can only make up to $5,000 worth of purchases.\u00a0<\/p>\t\t\t\t\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t

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Grace Period <\/h3>\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t
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This is the time period between when the credit card company issues your statement until your payment due date. Grace periods vary, but they\u2019re usually somewhere between 20 and 25 days. If you pay your card off in full during the grace period, you\u2019ll pay no interest. This essentially turns your credit card into a free short-term loan.\u00a0\u00a0\u00a0\u00a0\u00a0<\/p>\t\t\t\t\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t

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Variable Interest Rate<\/h3>\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t
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Credit cards can come with a fixed interest rate, which typically doesn\u2019t change, or a variable interest rate. If your card has a variable interest rate, the rate can go up or down based on the index rate, which fluctuates based on how the U.S. economy is performing.\u00a0\u00a0<\/p>\n

It\u2019s quite common for credit cards to come with a variable interest rate. You can check any card issuer\u2019s variable interest rate on the Consumer Financial Protection Bureau (CFPB)\u00a0website<\/a>.\u00a0<\/p>\t\t\t\t\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t

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How Credit Card Companies Make Money<\/h2>\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t
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Credit card companies make money by charging you interest on the purchases you make. They want you to carry a balance. The higher your balance, the more money they make as long as you don\u2019t default.<\/p>\n

If you\u00a0pay off your total credit card bill every month before the payment due date<\/a>, you won\u2019t pay any interest at all. Used this way, credit cards work almost like debit cards. You make purchases with your credit card all month. Then you pay down the balance and the money comes out of your checking account. By paying it off in full every month, you won\u2019t pay any interest or fees.<\/p>\n

The reality is that most people don\u2019t pay off their entire credit card bill each month, the average American has\u00a0$6,354 in credit card debt<\/a>.<\/p>\n

Credit card companies know that the majority of cardholders can\u2019t pay off their bill each month. In fact, card issuers count on this being the case.<\/p>\n

Every credit card has a minimum payment you must make to keep your account in good standing. The minimum payment varies based on your total balance, as well as any fluctuations in your card\u2019s interest rate.\u00a0<\/p>\n

While making the minimum payment will keep your account in good standing, it\u2019s usually a bad idea to only male a minimum payment. Your balance continues to accrue interest from month to month. This is great for the credit card company, but not so great for you.<\/p>\n

Let\u2019s say you have a credit card with a $5,000 balance and an APR of 18%. If you only make a minimum payment of $100 each month, it\u2019ll take almost 8 years and $4,311 in interest to pay it off. You\u2019d be paying almost in interest as your original balance. That\u2019s like walking around and insisting that every store charges you double just for the fun of it.<\/p>\n

Remember this rule:\u00a0paying the minimum balance means you pay double for everything<\/strong>.<\/p>\n

Always pay your cards off in full every month. And if you can\u2019t, pay as much as you can.\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0<\/p>\t\t\t\t\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t

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Different Types of Credit Cards<\/h2>\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t
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There are several different types of credit cards available. Some are marketed toward people with excellent credit, while others are designed for those who want to repair a bad credit score.<\/p>\n

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You can also find cards that offer lucrative rewards, as well as those made specifically for transferring a balance from a high-interest card. Here are a few of the most popular types of cards available.\u00a0\u00a0<\/p>\n

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1. Standard Credit Cards<\/h3>\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t
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Standard credit cards are basic cards that lack frills or rewards. These are the everyday run of the mill credit cards used to charge purchases and then pay them off.<\/p>\n

Many consumers like standard credit cards because they\u2019re straightforward and uncomplicated. If you don\u2019t want to keep track of rewards points, and you\u2019re not interested in spending a certain amount to trigger cash back bonuses or other perks, a standard credit card might be a good fit for you.<\/p>\t\t\t\t\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t

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2. Rewards Credit Cards<\/h3>\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t
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This is where stuff gets fun. Once your credit is good enough, you can get a rewards card. There\u2019s a lot of different types but in general, you get 2% back on anything you spend. Sometimes it\u2019s straight cash back, sometimes it\u2019s miles or points that can be redeemed for travel. Some of them also come with perks like free hotel room upgrades, airport lounge access, and free airline companion tickets.<\/p>\n

At the very least, get a good cash back card. And if you like to travel, get a good travel rewards card. You\u2019ll travel like a VIP for free.<\/p>\t\t\t\t\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t

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3. Secured Credit Cards<\/h3>\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t
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Secured credit cards are typically marketed toward people who need to rebuild their credit. With a secured card, you must pay a security deposit up front. This acts as collateral for the lender, who can keep your deposit if you end up defaulting on the card.<\/p>\n

In most cases, your security deposit is also your credit limit. For example, if your card requires a $200 security deposit, you can only charge up to $200 on your card.<\/p>\n

You might be wondering why anyone would want a card with these kinds of requirements and restrictions.<\/p>\n

One of the biggest draws of secured cards is that the card issuer reports account history to the three major credit bureaus: Experian, Equifax, and TransUnion. If your credit score is poor, making regular, on-time payments on a secured credit card can help reestablish you as a responsible credit user.<\/p>\n

They\u2019re also available to folks that can\u2019t get any other credit card because of a credit history that\u2019s too low.<\/p>\t\t\t\t\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t

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The world wants you to be vanilla...<\/div>\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t
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\u2026but you don\u2019t have to take the same path as everyone else. How would it look if you designed a Rich Life on your own terms? Take our quiz and find out: <\/p>\t\t\t\t\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t

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\n\t\t\t\t\t\n\t\t\t\t\t\t\n\t\t\t\t\t\t\t\t\tTake the Quiz<\/span>\n\t\t\t\t\t<\/span>\n\t\t\t\t\t<\/a>\n\t\t\t\t<\/div>\n\t\t\t\t\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t\t<\/div>\n\t\t<\/div>\n\t\t\t\t\t<\/div>\n\t\t<\/section>\n\t\t\t\t
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4. Prepaid Cards<\/h3>\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t
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As the name indicates, prepaid credit cards require users to load money onto their card before using it. Technically, these aren’t credit cards. Instead, they function more like a debit card.<\/p>\n

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In some cases, people use prepaid cards because their credit score is too low for them to qualify for a regular credit card. They might also use a prepaid card if they don’t have a bank account.\u00a0<\/p>\n

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5. Balance Transfer Credit Cards<\/h3>\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t
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Balance transfer credit cards offer consumers a way to shift their credit card debt from one credit card to another. In most cases, people do this to save money on interest. For example, if they have a significant balance on a high-interest credit card, they might want to transfer that debt to a card that offers more favorable terms.<\/p>\n

In many cases, balance transfer cards offer attractive introductory terms as a way of getting people to sign up. It\u2019s common for them to give cardholders 12 months of 0% APR.<\/p>\n

It\u2019s important to be careful with balance transfer cards, however, because interest rates often skyrocket once the promotional or introductory period ends.<\/p>\t\t\t\t\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t

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Applying For Credit Cards<\/h2>\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t
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These days, applying for a credit card is usually an easy and straightforward process. Because most applications are available online, you can check out the requirements before submitting your information.<\/p>\n

Be wary about submitting too many applications at once. In many cases, applying for a credit card causes the credit card company to pull your credit, resulting in a hard inquiry on your credit report.<\/p>\n

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While one or two hard inquiries won\u2019t affect your credit score much, accumulating too many of them can drop your score for several months. When you apply for too much credit all at once, potential creditors can view this as a red flag that you\u2019re in desperate need of extra cash.<\/p>\n

This is why you should do your research and only apply for cards you really want. Make sure you review the qualification requirements so you don\u2019t submit an application for a card you most likely won\u2019t get. For example, if a card requires a 750 credit score and your score is just above 600, it\u2019s probably best to focus on cards with less stringent requirements.<\/p>\n

It\u2019s also a good idea to never apply for new credit cards right before you apply for another major loan like a mortgage or a car loan. You want your credit score as high as possible for those applications.<\/p>\t\t\t\t\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t

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Credit Scores and Other Factors for Getting a Credit Card<\/h2>\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t
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Your credit score is by far the most important factor in determining whether you qualify for a credit card. Credit card companies want a snapshot of how you use credit. And your credit score is a three-digit number that gives them a quick assessment of how well you\u2019ve handled credit in the past.<\/p>\n

However, other factors play a role, too. This is why someone with an excellent credit score might still get turned down for a credit card, whereas another person with a mediocre score could qualify. Generally, someone with an excellent credit score probably won\u2019t have much trouble getting approved for a credit card.\u00a0<\/p>\n

In addition to your credit score, credit card companies also consider the following factors when deciding to approve you for a card:<\/p>\n