What Is a Credit Card? Benefits, Drawbacks, Types, and How It Works
A credit card is one of the most powerful and convenient financial tools available today. It allows you to borrow money for purchases or cash withdrawals — giving you the flexibility to pay later. But while credit cards offer numerous perks, misuse can lead to high-interest debt and long-term financial problems.
What Is a Credit Card?
A credit card is a payment card issued by banks or financial institutions that allows you to borrow money up to a certain limit (credit limit) to make purchases or withdraw cash.
Each month, you receive a billing statement:
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You can either pay the full balance (no interest charged), or
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Pay a portion, and the remaining balance will accrue interest (APR).
If you spend over your credit limit, the issuer may charge an over-limit fee.
How Do Credit Cards Work?
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You use your credit card to make a purchase.
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The credit card issuer pays the merchant on your behalf.
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You get a monthly bill with a due date.
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Pay it in full = No interest
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Pay the minimum = Interest charged on the remaining balance
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What Is APR (Annual Percentage Rate)?
APR is the annual interest rate you’ll be charged on any unpaid balance.
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Some cards have fixed APR, others have variable APR (tied to prime rate).
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Many credit cards offer 0% introductory APR for 6–21 months, great for balance transfers or large purchases.
⚠️ The average credit card APR ranges from 18% to 25%, which is much higher than most other loans.
Cash Advances: Use with Caution
Credit cards allow you to withdraw cash from an ATM (called a cash advance), but:
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Interest starts immediately — no grace period
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Higher APR than regular purchases
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Cash advance fee + ATM fee
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No rewards or cashback
🔑 Use only in emergencies.
What Is a Balance Transfer?
A balance transfer lets you move debt from one credit card to another — often to take advantage of a 0% or low introductory APR.
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Helpful for paying off high-interest debt
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Some cards charge a 3–4% transfer fee
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Best used if you can pay off the balance during the promotional period
Credit Card vs Debit Card
| Feature | Credit Card | Debit Card |
|---|---|---|
| Source of Funds | Borrowed from the bank | Your own money |
| Interest Charges | Only if balance isn’t paid off | No interest |
| Rewards | Cashback, miles, perks | Limited or none |
| Fraud Protection | Strong (often zero liability) | Less protection |
| Credit Score | Helps build credit | No impact |
Drawbacks of Credit Cards
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High interest rates if you carry a balance
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Easy to overspend, leading to debt
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Late payments hurt your credit score
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Hidden fees (late fees, foreign transaction fees, etc.)
🔑 Solution: Stick to a budget, pay in full each month, and avoid impulsive spending.
Benefits of Using a Credit Card
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Buy Now, Pay Later – Ideal for short-term borrowing
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Security – Safer than carrying cash; strong fraud protection
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Cashback & Rewards – 1%–5% back on eligible purchases
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Purchase Protection – Covers theft, damage, and price drops
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Perks & Extras – Travel insurance, rental car coverage, lounge access, and more
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Build Credit History – On-time payments improve your credit score
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Emergency Funding – Useful in urgent or unexpected situations
Types of Credit Cards
| Type | Description |
|---|---|
| Cashback Cards | Earn 1%–5% back on purchases; some rotate bonus categories quarterly |
| Rewards Cards | Earn points or miles for travel, dining, or shopping |
| Balance Transfer | Low or 0% APR for transferring balances from other cards |
| Secured Cards | Require a refundable deposit; good for building or rebuilding credit |
| Prepaid Cards | Load money in advance; no credit check, doesn’t build credit |
| Store Cards | Retail-specific cards offering discounts and promotions |
| Charge Cards | No preset limit, but balance must be paid in full monthly |
| Business Cards | Designed for business expenses and tracking; offer business-specific perks |
How Is Credit Card Interest Calculated?
Most issuers use the Average Daily Balance (ADB) method.
Step-by-step:
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Calculate Daily Periodic Rate (DPR):
DPR = APR ÷ 365 -
Calculate ADB:
(Sum of daily balances during billing cycle) ÷ (number of days) -
Calculate interest:
Interest = DPR × ADB × number of days in billing cycle
Example:
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APR = 15% → DPR = 0.00041
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First 15 days: $500 balance, last 15 days: $400
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ADB = (15×500 + 15×400)/30 = $450
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Interest = 0.00041 × 450 × 30 = $5.54
Other less common methods:
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Previous Balance – based on last month’s closing balance
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Adjusted Balance – previous balance minus payments made