When you buy something using this page, we may earn a small affiliate commission. The Los Angeles Times newsroom was not involved in the creation of this content.

How Do Credit Cards Work? Understanding the Basics of Credit Cards

Holly D. Johnson - Contributor Updated: 25 January 2023 9 Min Read
Why Trust Us?

Credit cards let consumers make purchases or pay bills.

When you use a credit card, however, you’re borrowing against a line of credit that was assigned to you when you were approved. You can use your credit card up to the credit limit if you prefer, but there’s no obligation to use a credit card at all.

While credit cards and debit cards look very similar, there are some huge differences in terms of how they work, their protection against fraud, and their perks and features.

If you’re curious whether you should get a credit card, arming yourself with information is the first thing you should do. Read on to learn how credit cards work in practice, which credit card fees you may have to pay, and how to use credit to your advantage.

Key Takeaways on the Basics of Credit Cards:

Compare Best Credit Cards of 2023

Check your eligibility in minutes
Product Hero Image

What is a credit card?

A credit card is a rectangular piece of plastic (or metal in some cases) consumers can use to make purchases or pay bills.

In some cases, credit cards can also be used to withdraw cash from an ATM, although cash advance fees will apply.

When you apply for a credit card, credit card companies consider your credit score, your credit history, your income, your debt-to-income ratio and other factors before they approve you. If they deem you creditworthy, you’ll be issued a credit card with a set credit limit you can borrow against.

Your credit limit could be anywhere from $300 to $20,000 or more, but this figure represents the limit you can spend on purchases and bills. Over time, your card issuer may offer you an increase to your credit limit if you remain in good standing. As you make purchases on your card, the amount of available credit you have will decrease.

In a lot of ways, a credit card can serve as a flexible, short-term loan. Just keep in mind that, like personal loans, auto loans, and other types of debt, you’re responsible for repaying every cent you borrow plus transaction fees and interest charges.

How do credit cards work?

As we mentioned already, you can use a credit card to pay for purchases and bills in-person or online, and you can do so until you spend up to your credit limit.

When you use a credit card to pay for a purchase, your credit card details are sent to the merchant’s bank for authorization. The bank seeks out authorization from the credit card network, which allows them to process the transaction and approve your card for the charges.

If the transaction is approved by all the interested parties, your credit card issuer will pay the merchant electronically on your behalf.

Your credit card also has billing cycles, which are usually around 30 days long. You’ll get a credit card bill at the end of each billing cycle that lists all the purchases you made. From there, you’ll have a period of time known as a grace period to make a payment on your credit card.

You can choose to make a minimum payment on your credit card, which is usually anywhere from 2% to 4% of your balance. If you choose to make the minimum payment or any payment that’s less than the full amount you owe, you’ll begin accruing interest charges based on your credit card’s APR and your revolving balance.

On the flipside, you can also pay your credit card balance in full by your the due date. In this case, you won’t owe any interest charges since you’re not carrying a revolving balance from one month to the next.

Credit cards vs. Debit cards

Credit cards and debit cards can look very similar.

However, these two financial products don’t work the same at all. When you make purchases with a credit card, you’re actually borrowing money with the promise to pay it back, plus interest and fees, at a later date. When you pay for something with a debit card, on the other hand, you’re paying for the purchase with cash that will be debited from a connected bank account.

In the meantime, there are additional differences between credit cards and debit cards. For example, credit cards report your credit balances and payments to the credit bureaus — Experian, Equifax, and TransUnion. They help you build credit as a result, which means using a credit card can help you improve your credit score.

By contrast, debit cards don’t report your purchases to the credit bureaus since you’re spending your own money. This means using a debit card only won’t help you build credit at all.

It’s also worth noting how different credit cards and debit cards work in terms of liability.

If a fraudster gets their hands on your credit card or your card number, you can only be liable for up to $50 in financial losses per details in the The Fair Credit Billing Act (FCBA). On top of that, most credit cards promise their customers 0% liability protection.

With a debit card, on the other hand, you won’t have similar protections. In fact, if you don’t report a fraudulent debit card charge within 60 days after receiving your credit card statement in the mail, the Federal Trade Commission (FTC) says you could lose “all the money taken from your ATM/debit card account, and possibly more; for example, money in accounts linked to your debit account.”

Finally, credit cards offer the potential to earn rewards in the form of cash back, statement credits, gift cards, or travel points. Co-branded credit cards from hotels and airlines also make it possible to earn airline miles or hotel loyalty points.

With a debit card, you’re unlikely to earn any type of reward at all.

Credit cards vs. Debit cards

  Credit Cards Debit Cards
Where the money for purchases comes from A line of credit you borrow against Your own bank account
Builds credit Yes No
Ability to rack up credit card debt Yes No
Potential to earn rewards on spending Yes Unlikely

In addition to the interest charges credit cards can tack onto everything you buy, there are additional credit card fees to be aware of.

Common credit card fees to watch out for include the following:

Types of credit cards

There are many types of credit cards on the market today, each of which comes with its own selection of pros and cons.

Common card types include the following:

Benefits of using a credit card

Using a credit card can be beneficial in more than one way, but it all depends on how you use credit on a daily basis.

If you use a credit card to earn rewards or take advantage of cardholder perks or consumer protections, that strategy can make a lot of sense. Just keep in mind that the high interest rates credit cards charge can wipe out any benefits in a hurry. With that in mind, we only suggest using credit cards for purchases you can afford to pay off and striving to only carry a balance if you have to.

In addition to the perks and benefits you can get from the right card, it’s also important to remember that credit cards are powerful credit-building tools. By using your card for purchases and paying it off early or on time each month, you can prove your creditworthiness and boost your credit score over time.

Credit cards can also become valuable in an emergency. If you lose your job, face surprise car repairs, or run into any other financial emergency, having a line of credit in place can help you get back on your feet faster than you might be able to otherwise.

How to build credit with a credit card

If you decide you do want your own credit card, you should use it to build credit you’ll definitely need later in life.

Important steps you should take to build a good credit score include the following:

Credit card basics and terms

While we already explained how credit cards work in general terms, knowing all the basic credit-related terms can help you understand more about this financial product.

Below you can find an explanation of the most common credit card terms you should know about:

Compare Best Credit Cards of 2023

Check your eligibility in minutes
Product Hero Image
Holly D. Johnson
Holly D. Johnson Contributor

Holly D. Johnson is an award-winning personal finance writer who covers topics like insurance, investing, credit and family finance. As a leading voice in the travel and loyalty space, Johnson has traveled with her family to more than 50 countries over the last decade. 

The author has also written extensively on the power of household budgeting, and she even co-authored a book on the topic. Zero Down Your Debt: Reclaim Your Income and Build a Life You’ll Love was originally published in 2017, and it teaches families how to use zero-sum budgeting to reach their financial goals. She is also the co-owner and founder of the family finance and travel website, ClubThrifty.com.

Johnson’s 10+ years of writing have focused on helping families make important financial decisions at each stage of their lives. The author also applies the financial principles she teaches to her own life, and she is currently on track to retire in her late 40’s with her partner. She currently lives in Central Indiana with her husband and children, and she is a regular contributor for Bankrate, CNN, Forbes, U.S. News and World Report Travel and many other notable publications.