How Do Credit Cards Work? (A Complete Guide)

Whether you’re a seasoned cardholder or have never had a credit card before, you likely have questions about how they work. How interest is calculated, how balance transfers work, what happens when your payment is late—these are all questions with answers that aren’t necessarily intuitive.

Think of this article as Credit Card 101. We’ll be covering all the ins and outs of credit cards and how they work. You’ll get answers to all of your credit-card-related questions, which will empower you to make smart decisions with your own card.

What Is a Credit Card, and How Does It Work?

A credit card is a payment card that allows you to borrow money to purchase goods and services. The card is connected to an account that has a credit limit, which is the maximum amount of money that can be borrowed through the account.

Credit cards are a form of revolving credit, which means that you can borrow money, pay it back, then borrow it again, provided you make timely payments and stay within your credit limit.

You can use your card for in-person purchases, online shopping, over the phone, or through mobile wallets and peer-to-peer payment apps.

How Are Credit Card Transactions Processed?

When a merchant runs your credit card, the payment approval process¹ that occurs behind the scenes is the same whether you swipe a magnetic stripe card, insert a chip card, tap a contactless card reader, or manually enter your card information:

1. The merchant’s point-of-sale system or website sends the transaction details to a credit card processor
2. The card processor encrypts the data and forwards it to the merchant’s bank, known as the “acquiring bank”
3. The acquiring bank transmits the transaction information to the appropriate credit card network (generally Visa, Mastercard, Discover, or American Express) to begin the authorization process
4. The credit card network submits an authorization request to the cardholder’s bank, known as the “issuing bank”
5. The issuing bank verifies the available credit and checks for any indications of fraud
6. The approval (or decline) travels back through the network, processor, and merchant, displaying “Approved” on the terminal

This process takes just seconds, ensuring a smooth experience whether shopping in-store or online.

How Does Credit Card Interest Work?

Calculating the interest on your credit card purchases can be more complex than it seems, even if you know your card’s interest rate. Credit card interest is based on the annual percentage rate (APR), but in most cases, it’s applied daily as a daily percentage rate (DPR). Note that there are actually multiple computational methods used by credit card issuers, and the one your issuer uses will depend on the terms of your card agreement. For the purposes of this article, we'll cover one of the most common methods, which is based on an average daily percentage rate.

To determine your interest charges², you’ll need to convert the APR to a DPR and calculate your average daily balance (ADB) for the billing period. Here’s how it works:

• Convert APR to DPR: Divide your APR by 365 (the number of days in a year). For example, if your card has a 15% APR, divide 15 by 365 to get a DPR of 0.041%. Note that during a leap year, you would instead divide by 366.
• Calculate Average Daily Balance (ADB): Identify the days in your billing period and record your account balance for each day. Add these daily balances together, then divide by the number of days in the billing period. For instance, in a 30-day billing cycle, if your balance was $700 for 11 days, $500 for 5 days after a payment, and $800 for 14 days after a purchase:
  • (11 × 700) + (5 × 500) + (14 × 800) = 7,700 + 2,500 + 11,200 = 21,400
  • 21,400 ÷ 30 = $713.33 (ADB)
• Calculate Interest: Multiply your ADB by the DPR, then multiply by the number of days in the billing cycle. Using the example above:
  • ($713.33 × 0.00041) × 30 = $8.78 in interest

Also, keep in mind that if you pay your balance in full every month, you generally won’t have to pay interest on your purchases. Interest is only applied if your account carries a balance after your current billing cycle’s closing date.

Credit Card Rewards and Perks

Many credit cards have rewards and perks, such as a 0% introductory APR, cash back rewards, airline miles, concierge services, and points earned on purchases that can be redeemed for gift cards and other rewards.

Rewards such as a 0% introductory APR or concierge services are straightforward enough, but things like cash back rewards and credit card points often have additional details that influence how you use your card. Let’s take a closer look at each.

How Do Cash Back Credit Cards Work?

The concept behind cash back credit cards is simple enough: For every dollar you spend with your card, you earn a specified percentage back in cash or other rewards. For example, if your card offers 1% cash back, then for every $100 you charge to your card, you’ll earn $1 back.

While this is the basic framework, there are generally three different types of cash back cards:

• Flat-Rate Cards: These are the simplest cash back cards, offering a consistent reward rate on all purchases. For example, with Hancock Whitney’s Visa Platinum Rewards Card, you earn 1.5% cash back on every purchase, making it ideal for those who want predictable rewards without tracking categories.
• Tiered-Rate Cards: These cards offer higher cash back rates for specific purchase categories, such as 3% on groceries or gas and 1% on everything else. This type suits you if you spend heavily in certain areas, like dining or travel, and want to maximize returns on those purchases.
• Rotating-Bonus Cards: These cards feature quarterly bonus categories with higher cash back rates, such as 5% on online shopping one quarter and groceries the next, with a standard 1% on other purchases. They’re great for flexible spenders who can adapt to changing categories.

You can generally redeem cash back as statement credits, direct deposits, or gift cards, per your cardholder agreement.

How Do Rewards Cards and Credit Card Points Work?

Points-based rewards credit cards let you turn everyday purchases into valuable perks, functioning similarly to cash back cards but with points instead of cash. With each dollar you spend, you earn points that can be redeemed for exciting rewards like travel or gift cards. For example, your card may offer 3 points per $1 spent on dining, making it easy to rack up rewards at your favorite restaurants.

The number of points you earn depends on your card’s terms. Some cards award 1 point per $1 spent, while others, may offer 3 points per $1 in specific categories, such as dining or travel, and 1 point per $1 on other purchases.

Once you’ve accumulated enough points, you can redeem them for a variety of rewards, such as statement credits, gift cards, airline miles, hotel stays, rental cars, or even vacation packages. Check your cardholder agreement for redemption thresholds and options to maximize your benefits.

How Do Credit Card Fees Work?

The exact fees that come with your credit card will depend on the terms found in your cardholder agreement. Understanding these charges helps you manage your card wisely and avoid surprises. These are a few of the most common:

• Annual Fees: This is a yearly fee charged for maintaining the credit card account. Think of it like a membership fee. Not all credit cards have an annual fee.
• Late Fees: Late fees are applied to your account balance when you miss a payment. Missed payments can also damage your credit score. Set up autopay or reminders to stay on track and protect your credit.
• Balance Transfer Fees: This fee is applied when you transfer one card’s balance to another (usually to take advantage of a lower interest rate or promotional offer). The amount is usually a percentage of the balance transferred.
• Cash Advance Fees: If you use your credit card to withdraw cash, you’ll generally be charged a cash advance fee. This is usually a percentage of the amount of cash withdrawn. These fees, plus higher interest rates, can make cash advances costly, so use them sparingly.
• Foreign Transaction Fees: If you use your credit card to make a purchase in a foreign country (including making an online purchase from a business located in a foreign country), you may be charged a foreign transaction fee. This fee will be a percentage of the purchase amount.

Unsecured vs. Secured Credit Cards

Credit cards come in two main types: unsecured and secured. Unsecured credit cards are the most common and are what people typically think of with credit cards.

With an unsecured credit card, you generally simply apply for a card and (if approved) receive an account with a credit limit and interest rate determined by your credit score. From there, you can use your card to make purchases as long as you continue to make timely, monthly payments.

Secured credit cards are less common and are designed for those with no credit or poor credit scores. These cards are used as a tool to build credit to the point where an individual can qualify for an unsecured credit card.

Generally with a secured credit card, the cardholder must “secure” the credit by first paying a deposit on the card that acts as collateral. This deposit amount is often equal to the credit limit on the card. In the event that the cardholder misses too many payments, the deposit is forfeited. The goal with secured credit cards is to show that you can properly manage credit and payments as you improve your credit score.

How Do Credit Card Balance Transfers Work?

When you initiate a credit card balance transfer, you’re transferring the balance on one credit card to another. There are several reasons why you might want to do this, but the most common reason is that by moving the balance to a card with a lower interest rate, you’ll pay less in interest over time. You might even be able to take advantage of a 0% introductory APR.

How the balance transfer works is fairly straightforward. Generally, you’ll need to provide the account number and amount of the balance you want to transfer over. From there, the new credit card will effectively pay the old credit card the amount you specified, adding it to your new card’s balance.

You’ll also likely pay a balance transfer fee, which will be a percentage of the balance transferred at a rate specified in your cardholder agreement. This fee is then added to your balance.

How Do Credit Card Cash Advances Work?

Taking out a cash advance on your credit card allows you to borrow against your credit limit, giving you quick access to funds. The way that you receive this cash will depend on your exact credit card, but these are some common methods:

• Checks: Some credit cards will provide checks for cash advances. They’re effectively checks that, when used, add to the balance on your credit card account rather than drawing from a checking account.
• Banks and Credit Unions: You’ll first need to locate a bank that is affiliated with your credit card network (Visa, Mastercard, Discover, American Express, etc.), and then inquire if the financial institution can perform a cash advance on your card. (It’s a good idea to call ahead first.)
• ATMs: You can perform a credit card cash advance at most ATMs, but be aware that you might have to pay an out-of-network fee and that you’ll need to know your credit card’s PIN first.
• Direct Deposit: The most convenient method is having the cash advance deposited directly to your bank account. You might even be able to initiate this process through your card’s online banking or mobile app.

Be aware that cash advances from a credit card often come with significantly higher interest rates and a cash advance fee that is a percentage of the total amount of cash you withdraw. To keep costs low, use cash advances sparingly and explore alternatives for larger amounts, like personal loans.

Are You Ready for a New Credit Card?

Now that you understand how credit cards work, explore Hancock Whitney’s credit cards, designed to meet your needs. Our cards can help you achieve your financial goals while earning rewards on your purchases.

To apply for a Hancock Whitney credit card, simply contact our bankers today or apply online.