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When used wisely, a credit card is a great tool for consumers. It’s important for every consumer to understand what a credit card is and what types of credit cards are available to them.
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Credit Cards 101
What is a Credit Card?
Starting at the beginning, a credit card is a small plastic or metal card issued by a bank or institution. It is a tool that allows consumers to take out loans in order to make payments. At the end of a month, the consumer then must pay back the loan in full or pay interest on any delayed payments. The benefit of credit cards is that they typically offer rewards (i.e. 1% cash back) to consumers who use their cards.
How Does a Credit Card Work?
Simply stated, a credit card allows you to make purchases throughout a time period (usually a month) without actually paying for anything until the end of the time period. The simple steps to getting and using a credit card are as follows:
- Applying: you must apply for credit card. The higher your credit score, the higher chance you will have of obtaining a good credit card.
- Using: Once you have a credit card, you can use it to make purchases throughout a month or time period. You do not owe any money on the purchases you make until the end of the time period.
- Paying: At the end of the time period, you will get a statement with what you owe based on your purchases. It’s best to pay the credit card off in full every month. So, if you spent $100 on your last monthly statement, you pay $100 in full. If you do not pay off the full balance, you are likely subject to additional interest charges.
- Rewards: One of the largest benefits to credit cards is that they offer rewards to users. For example, many cards offer 1.5% cash back on all purchases, which is essentially having everything be on a 1.5% sale for the rest of your life.
One of the easiest ways to understand credit cards is to compare them to debit cards. With debit cards, you instantly pay (with money coming out of a checking account) as you make a purchase. With credit cards, you delay having to pay until the end of a time period.
Credit Card Pros and Cons
- Rewards: Many credit cards offer fantastic rewards (cash back, points, travel credits and other offers). You can view a list of rewards credit cards here.
- Building Credit: When used responsibly, having a credit card will help you build credit and receive better interest rates on large future purchases that require a loan (such as homes and cars).
- Convenience: Carrying a small card around instead of cash and coins is more convenient and safer. If you lose your card, you can usually cancel it quickly to avoid losing any money to a potential thief.
- Time Value of Money: A minor benefit, but one nonetheless, money in your pocket now is worth more in the future. Being able to delay payment until the end of the month allows you to earn more with your money, whether through investments or high interest savings accounts.
- Interest: If you are late paying off your credit card you will likely pay interest on top of what you owe. This is a large risk and huge reason to always pay on time and in full (when possible). Interest has the ability to quickly build up, erode any credit card rewards and send people into debt.
- Frivolous Spending: While delaying payment can sometimes feel like you are not paying at all, it is important to remember to not make any purchases you cannot afford. If you have a budget, stick to it. If you need rationale on why, re-read the “interest” bullet above.
Annual Fee vs No Annual Fee
The first question when diving into types of credit cards is if you want to select a card with an annual fee or with no annual fee. An annual fee is a one time payment you make each year (i.e. $100) to use your credit card. In exchange, you typically get better rewards (i.e. 2% cash back instead of 1% cash back).
The answer to this question is usually quite simple, but it requires some math. In general, low spenders (or someone who does not travel) should utilize no annual fee cards while high spenders (or frequent travelers) can benefit from annual fee cards (if they spend a lot in the card’s niche). See the brief example below comparing two Chase credit cards:
- Chase Freedom Unlimited
- $0 annual fee
- 1.5% cash back
- Chase Sapphire Reserve Card (niche = travel/dining)
- $450 annual fee (but only $150 fee when using the $300 travel credit)
- 3% back on travel expenditures (assumption below: 30% spent on travel and dining)
- 1% back on everything else
- Earn 50% more when using points for travel (assumption below: all rewards are redeemed for travel)
Person A: Low Spender, $500 / Month
- Chase Freedom Unlimited: Earns $90 annually
- Chase Sapphire Reserve Card: Earns $144 annually (assumptions: spending 30% on travel / dining and redeeming all rewards for travel), but with a cost of $150 the net it -$6 annually.
Person B: High Spender, $2,500 / Month
- Chase Freedom Unlimited: Earns $450 annually
- Chase Sapphire Reserve Card: Earns $720 annually (assumptions: spending 30% on travel / dining and redeeming all rewards for travel), and with a cost of $150 the net it $570.
Want us to do the math for you? Check out our Credit Card Tool to get a card recommended for you based on your spending habits.
Ready to apply for an annual fee or no annual card? You can head here:
Types of Rewards Credit Cards
There are different types of rewards that credit cards offer, from simple cash back to various point systems. In general, the type of reward a card offers does not matter as much as the monetary value of that reward. As long as you spend money on that category every year, you will benefit from the rewards (if you do not stay in hotels when traveling, don’t get a hotel rewards card).
- Cash Back: Rewards with cash back to your account to either pay off your next bill, deposit to your bank account or sometimes shop via different outlets on the credit card’s website. Example: Chase Freedom Unlimited. [Explore Cash Back Credit Cards]
- General Travel / Points: Rewards with points that can be used to book travel (check the card program or various sites to see what points are worth, but typically 1 point = $0.01). Example: Chase Sapphire Reserve. [Explore Rewards Credit Cards]
- Airline: Specific travel card for an airline that gives you points (or miles) to book travel through the designated airline brand. Often offers additional perks like free checked bags or lounge access. Example: United Explorer Card. [Explore Airline Credit Cards]
- Hotel: Specific travel card for a hotel brand that gives you points to book travel through the designated hotel chain. Example: The World of Hyatt Credit Card. [Explore Hotel Rewards Credit Cards]
- Retail: A card that gives you extra rewards when shopping at a specific retailer (rewards are usually redeemed at that same retailer). Example: TJX Rewards Card.
0% APR Cards
Last on the list of types of credit cards are 0% APR and low interest cards. In general, these cards are best for consumers with credit card debt because the interest you owe on them is lower than typical cards. On the other hand, they usually offer less/no rewards because their benefit is giving you a discount on the debt you owe.
Again, general advice is to avoid the situation where you need to seek out 0% APR and low interest cards, but they can be a helpful tool for consumers in a high credit card debt situation.
Other Types of Credit Card Perks to Consider
With the above types of credit cards we focused mainly on direct monetary benefits and costs. There are some other factors to consider when choosing a card, including:
- Foreign transactions fees.
- Travel Perks: lounge access, free checked bags, etc.
- Travel Insurance: cancellation protection, delayed flight protection, etc.
- And much more. Be sure to diligently compare the details of credit cards before signing up!
Ready to apply now that you know about types of credit cards? Check out some of the best annual fee and no annual fee credit cards, or use our credit card tool to get a card recommended for you based on your spending habits.
Editorial Disclaimer: Opinions expressed here are the author’s alone, not those of any bank, credit card issuer, airlines or hotel chain, and have not been reviewed, approved or otherwise endorsed by any of these entities.