Information from the Washington State Department of Financial Institutions

How Credit Cards Work

Credit Terminology Image


Before signing up for a new credit card, it’s important to read the contract and understand how credit cards work. Below is common terms and conditions you will encounter.

Annual Percentage Rate (APR)

The annual percentage rate (APR) is the interest rate you’ll be charged if you carry over a balance from month to month. If the card has an introductory rate, you’ll see both that rate and the rate that will apply after the introductory rate expires.

The APR is your key to comparing costs regardless of the amount of credit or how long you have to repay it.

All creditors—banks, stores, car dealers, credit card companies, finance companies—must state the cost of their credit in terms of the finance charge and the APR.

Some credit cards are “fixed rate”, meaning the APR doesn’t change often. Even if the APR is a “fixed rate” it can change over time. However, the credit card company must tell you before increasing the fixed APR.

Other credit cards are variable rate where the interest rates will change according to some benchmark such as the prime rate (the rate businesses borrow at) or the Treasury bill rate (short-term government borrowing rates). Look for information on the credit card application and in the credit card agreement to see how often your card’s APR may change.

A single credit card may have several APRs:

  • One APR for purchases, another for cash advances, and yet another for balance transfers. The APRs for cash advances and balance transfers often are higher than the APR for purchases (for example, 14% for purchases, 18% for cash advances, and 19% for balance transfers).
  • Tiered APRs. Different rates are applied to different levels of the outstanding balance with the higher the balance, the higher the interest rate (for example, 16% on balances of $1–$500 and 17% on balances above $500).
  • A penalty APR. The APR may increase if you are late in making payments.
  • An introductory APR. A different rate will apply after the introductory rate expires. The introductory APR may be a low or teaser rate to get you to sign up. It is important to check out what the APR will be after the teaser expires.
  • A delayed APR. A different rate will apply in the future. For example, a card may advertise that there is “no interest until next March.” Again, it is important to check what your delayed APR will be.

Grace Periods

The grace period is the number of days you have to pay your bill in full without triggering a finance charge. For example, the credit card company may say that you have “25 days from the statement date, provided you paid your previous balance in full by the due date.” The statement date is given on the bill.

Other credit card companies may note the due date on the statement. Keep in mind that the date is the day the payment must be received. If you sent it in the mail on the due date or even paid it with your online bill payment service, it will most likely be late.

The grace period usually applies only to new purchases. Most credit cards do not give a grace period for cash advances and balance transfers. Instead, interest charges start right away.

If you carried over any part of your balance from the preceding month, you may not have a grace period for new purchases. Instead, you may be charged interest as soon as you make a purchase (in addition to being charged interest on the earlier balance you have not paid off). Look on the credit card application for information about the “method of computing the balance for purchases” to see if new purchases are included or excluded.

Fees

Some credit cards charge annual fees for using the card, a cash advance fee (typically, $5 minimum or 3%), a fee when you transfer a balance from another credit card ($5 minimum or 3%), late payment fee ($35), over-the-credit-limit fee ($30), credit-limit-increase fee, set-up fee (for new account), a fee if your payment check is returned ($25), and other fees for services (telephone payment, reporting to credit bureaus, reviewing your account, etc.)

Cash Advances

Some credit cards let you borrow cash in addition to making purchases on credit. If you plan to use your card for cash advances, look for information about use of ATMs, because there may be charges for using other banks’ ATMs and different APRs for cash advances.

Credit Limit

The credit limit is the maximum total amount--for purchases, cash advances, balance transfers, fees, and finance charges--you may charge on your credit card. If you go over this limit, you may have to pay an “over-the-credit-limit fee.”