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A credit card is nearly a required item to get by in today’s world. As such, it is a good idea to have at least a basic understanding of how they work. Fortunately, the basics of credit cards aren’t very complicated.

What is a Credit Card?
Simply put, a credit card is an extension of credit that comes with a piece of plastic that can be used to pay for goods and services almost anywhere. It is a line of credit: you have the ability to borrow up to $X at will, but you don’t actually borrow the money until you need it. It’s a very convenient way to borrow small amounts of money.

This convenience comes with a cost. Credit card interest rates are typically higher than the interest charged on a bank loan. While a bank loan might be prime plus a percent or two, credit cards usually start around prime plus eight percent. For this reason, you shouldn’t carry a balance on your credit card for an extended period of time.

How is my credit limit determined?
Your credit limit is determined by various factors. These include your credit rating and credit history, your income and your bank account balances. The better these are, the higher your limit. The biggest factor that is under your direct control is your credit rating, which is determined by your credit history. It is very important to pay off your debts on time in order to maintain your credit rating. Since a credit card is part of this credit history, it is important to pay off your credit card balances in a timely manner. If have poor credit or no credit (if you’re young and haven’t had any debts yet), you will likely get a very low limit. As you pay off your balances, your credit card issuer may increase your limit.

Beyond the Basics
No doubt you’ve heard about rewards cards. The most common is the airlines miles card, but there are other types out there. There are cards that give you gift cards to home improvement centers, cards that donate to charity, cards that give you discounts on gas, and cards that give you cash back. These cards can be a great option to save money on the items you’re going to buy anyway, but only if you’ll actually use the reward. Some of these cards also charge higher interest rates. If the rate is high enough, the extra interest can offset the value of any reward, so it’s important to evaluate a credit card without the reward and then pick the rewards card if it passes the test.

The intricacies of credit cards can become complicated, but the basics of all cards are the same. Once you understand the basics, you’re well on your way to using your credit wisely.

 

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