How Credit Cards Work

Using credit1 is one way to borrow money. Credit cards may be used to draw on a line of credit to make purchases with the understanding that you will pay that money back later with interest and, sometimes, additional fees.

1. Establish a line of credit

Behind every credit card is a line of credit. A line of credit is an agreement between you and your financial institution that outlines the terms of your agreement to borrow money using your credit card. This includes your credit limit (how much you can borrow), your annual percentage rate (APR)2, and other fees.

2. Use your card to make purchases

Every time you make a purchase with a credit card you are borrowing money from your financial institution under the terms you agreed to when you opened your line of credit.

3. Make payments

If you charge purchases to your credit card, you will be required to make a regular, minimum payment to your account. Minimum payments are calculated by your financial institution as outlined in the terms of your credit agreement, usually as a percentage of your overall balance. Try to pay off your balance in full every month to avoid paying interest and fees.

4. Build your credit history

Payment history accounts for approximately 35% of your credit score, so one way to build your credit score is to always pay your bills on time and in full. Also, people who use less of their available credit are considered lower risk, and so receive a higher credit score. A general rule of thumb is to use only 30% or less of your available credit.

1Credit is the provision of money, goods, or services with the expectation of future payment

2Annual Percentage Rate, or APR is the cost you pay for borrowing money, as expressed by an interest rate applied annually to a loan, such as a credit card or mortgage.

*Know your rights. The Credit CARD (Card Accountability Responsibility and Disclosure) Act of 2009 requires that creditors disclose important terms, like fees and interest, before the consumer signs an agreement to enter into a line of credit.