Credit Cards 101

Learn the basics of how credit cards work, from statement balances and APR to credit scores, fees, and fraud protection. This guide breaks down key terms and common pitfalls so you can use credit wisely, avoid costly mistakes, and make more confident financial decisions.

A credit card can be a great way to establish credit—as long as it’s used responsibly. If someone misuses their credit card or doesn’t fully understand how it works, it can also be a gateway to falling into debt and damaging their credit score. We want to help our customers bank responsibly, and that includes credit cards.
That’s why we put together this explainer of how credit cards work, to help you avoid potential pitfalls, as well as some credit card tips for beginners. Whether you’re new to the world of credit cards or have had one for a while, we hope this explainer on credit card basics can help you use one responsibly and avoid common credit card traps that could leave you with a pile of debt and a poor credit rating.

How Do Credit Cards Work?

A credit card is issued by a financial institution, such as a bank, and you can use it to buy things. Every time you make a purchase, you’re essentially borrowing that money and must pay it back. Your balance is what you owe on the card. Two terms that are often confused with each other are statement balance vs current balance. Your statement balance is what you owe on each month’s bill. Your current balance is the amount on your card.

For example, let’s say you had a $10,000 limit on a credit card. That’s the maximum amount of debt or charges that you can carry on that card at any given time. If your billing cycle was for each calendar month, when you receive your monthly statement in early February, it would reflect all charges made to your credit card in January.
If you started January with no balance on your credit card and you made $1,000 in purchases that month, when your January statement arrives it will show that your “statement balance” is $1,000. That’s the amount you would have to pay to avoid any interest charges, and you would typically have around 20 to 25 days to make that payment, which is known as “the grace period.”
If you made $500 in purchases during that grace period, then your current balance would be $1,500, but your statement balance for January would still be $1,000. That $500 in spending would be applied to your February statement.
Your available credit is the difference between your credit limit and what you owe on your card at any given time. In this case, until you pay your bill for January, your available credit would be $8,500 (your $10,000 credit limit, minus your $1,500 current balance). If you pay off your January credit card bill in full, then your available credit would be $9,500 (your $10,000 credit limit, minus your $500 in spending during the grace period).
It’s important to keep track of your credit limit and your current balance, especially if your balance frequently approaches your limit. If you exceed that limit, your credit card would be denied, and you would be unable to use it for purchases until you pay off at least a portion of your balance.
Each monthly credit card bill will also state your minimum payment, which is the smallest amount you could pay to keep your credit card in good standing. Of course, if you only make the minimum payment and fail to pay off your balance each month, that will lead to interest charges.

How Does Credit Card Interest Work and What’s an APR?

Credit card interest is based on an annual percentage rate (APR), which is expressed as a yearly percentage. If your credit card interest (APR) is 20%, you would divide that by 12 to figure out the interest you would be charged (1.67%) on any current balance you carry from month to month. Most credit cards have a variable APR, which fluctuates according to changes in interest rates and Federal Reserve policy.
Monthly interest charges are a good example of why it’s important to pay off your credit card balance in full each month. Any interest charges that you accrue in January will be added to your February statement balance. If you fail to pay off your balance in February, your interest costs will be added to your balance for March, along with any fees or service charges. You can wind up not only paying interest on your purchases, but you can also pay interest on top of interest, and those costs would continue to rise each month until you pay off your balance in full.

How Credit Cards Can Help or Hurt Your Credit Score

For many people a credit card is how they first start building credit. It can be a great way to establish a good credit history, as long as you pay off your balance in full each month and avoid charging more than you can afford. A credit score is a three-digit number that lenders use to determine whether to grant someone a loan (credit card, mortgage, auto loan, etc.) and how much interest they’ll have to pay.
You can check your credit score for free every week at AnnualCreditReport.com. It will give you three credit reports and scores from the nation’s three credit reporting bureaus: Equifax, Experian, and TransUnion. It’s a good idea to check your credit score at least once per year to look for any signs of fraud or identity theft. If you do see any mistakes, contact the bureau that lists the information in its report.
Two of the biggest factors in building a good credit score are your payment history (35%) and your credit utilization (30%). Payment history means paying all your bills on time. Credit utilization is your total amount of available credit, versus how much of that credit you’re actually using. If you’re frequently approaching the credit limit on your card or failing to pay your credit card (and other bills) on time, that’s going to hurt your credit score. Your length of credit history (how long you’ve had each account) makes up 15% of your credit score.

This is why it’s usually a good idea to hold onto any credit cards you have, even if you don’t use them very much. Credit card companies will cancel a card after a period of inactivity, which could range from six months to two years, so if you want to hold onto an old credit card, you’ll have to use it once in a while. Keeping an old card in good standing by using it once now and then, and paying off the balance in full, can help your credit score because it’s part of your length of credit history and your total available credit.

How Credit Card Cash Advances Work (and Why You Should Avoid Them)

One of the most misunderstood aspects of credit cards is how cash advances work, because they’re treated differently from regular purchases. When you withdraw cash against your credit card limit, it becomes part of your balance—but with a higher interest rate and fees. If the APR on your credit card is 20% for regular purchases and paying bills, the APR on cash advances could be up to 30%.
Here’s where a cash advance on a credit card can really get expensive. You will be charged the higher interest rate on a portion of your credit card balance until you pay your balance off in full. That’s why many financial advisors recommend only using a credit card cash advance in an emergency, and only if you can pay the balance off when your statement comes due.

How Credit Card Balance Transfers Work

Sometimes a credit card company will offer you a new credit card and an introductory interest rate or grace period on any balance you transfer from an existing card, so your new credit card company would pay off the balance on your old card. It’s basically transferring your credit card debt from one company to another. There would likely be a balance transfer fee based on the amount being transferred (such as 3% to 5%).
While these can be a good way to pay off your credit card debt faster, by reducing your interest costs, these offers can become a financial trap when not handled correctly. If you’re given a low introductory rate, or perhaps no interest at all on your balance transfer, it will only last for a given period, which may be several months to a year. Once that introductory period is over, any remaining balance you have will automatically be reset to a higher interest rate. If you can use that introductory period to pay off your balance in full, a balance transfer could be a good way to eliminate that debt. On the other hand, if you fail to pay off the balance on your new card, you could wind up paying more in fees and interest costs than you would’ve if you’d stuck with your existing credit card.

Watch out for Credit Card Fees

Every credit card has fees. There could be an annual fee, late payment fees, foreign transaction fees, etc. It’s important to be aware of what these fees are and how they could impact your finances before you accept a new credit card, so you can avoid any unnecessary costs.

Credit Card Perks and What to Watch for

Many credit cards offer rewards such as points or travel miles that you can redeem for merchandise, travel expenses, or apply to your existing balance. While these can be nice perks and help you financially, just make sure that you don’t use them as an excuse to spend more than you can afford. Otherwise, these benefits could cost you more in interest payments than they’re worth.

How Credit Card Fraud Protection Works

Credit cards typically offer fraud protection, where you wouldn’t be charged for unauthorized purchases. Make sure you understand the fraud protection services of your credit card and read every monthly statement carefully to look for any bogus transactions, as you’ll need to report them immediately to have them removed from your balance and to prevent additional fraud.

How to Use a Credit Card Responsibly

While credit cards offer convenience and security, they can also cost you a small fortune if you misuse them. It can be tempting to live beyond your means with a credit card. Many people discover that when they switch from using cash to using credit cards to pay for things, they tend to increase their spending. A “bargain” item on sale might save you money at the cash register, but that can quickly turn into debt and high-interest charges if you can’t pay off your balance. Having a monthly budget and sticking to it can help you avoid that pitfall.

Talk To a Banker About the Right Credit Option for You

If you’re weighing your credit card options and have a couple of offers on the table, one of our bankers could help you make the right decision. Please contact us to learn more or stop by one of our convenient locations in southern Wisconsin and northern Illinois. Our blog posts on Credit Card Safety Tips and 5 Signs It’s the Wrong Credit Card for You offer additional information, and our post on How to Create a Budget and Stick With It can help you with budgeting responsibly and living within your means.