A credit card is a payment card that enables the cardholder to borrow funds from a financial institution up to a specific credit limit. The cardholder can then use the card to make purchases, withdraw cash, or transfer funds to other accounts. The funds borrowed are usually repaid later, either in whole or in part, with interest or additional fees charged for the convenience of using the credit.
How credit cards work
Banks, credit unions, and other financial institutions issue credit cards. When a person applies for a credit card, the issuer assesses their creditworthiness based on various parameters, including credit score, income, and debt-to-income ratio. If the person is approved, the issuer assigns them a credit limit, the maximum amount of money they can borrow using the card.
When the cardholder uses the credit card to make a purchase, the issuer pays the merchant on their behalf, and the cardholder incurs a debt to the issuer for that amount. The cardholder must then make at least the minimum payment on the balance each month, including interest charges and any other fees assessed by the issuer.
If the cardholder does not repay the balance in full each month, interest charges accrue on the unpaid balance, which increases the total amount owed. Additionally, if the cardholder misses a payment or exceeds their credit limit, they may be subject to additional fees and penalties.
Credit card rewards:
Many credit cards offer rewards programs, which allow cardholders to earn points, miles, or cash back for using their cards to make purchases. Rewards can be redeemed for various things, such as travel, merchandise, or statement credits.
Credit card fees:
Credit cards may have additional fees besides interest charges, such as annual fees, cash advance fees, balance transfer fees, foreign transaction fees, etc. Cardholders need to be aware of these fees and factor them into their decision-making when choosing a credit card.
Credit card security:
Credit cards are generally safe to use, as they offer protection against fraudulent charges. Card issuers typically monitor for unusual activity and may contact the cardholder if they suspect fraud. Additionally, many credit cards offer fraud protection and zero liability for unauthorized purchases.
Additional points about credit cards that may be helpful
- Credit utilization: Credit utilization is the percentage of available credit a cardholder uses. It is an essential factor in calculating credit scores, and experts recommend keeping credit utilization below 30% to maintain a good score.
- Grace period: A grace period is the amount of time a cardholder has to pay their balance in full without accruing interest charges. Grace periods can vary by the card issuer and may not apply to all transactions.
- Credit limit increase: Cardholders may request a credit limit increase, which can improve their credit utilization and borrowing capacity. However, card issuers may require additional information or a credit check before approving a limit increase.
- Credit score impact: Using credit cards responsibly and making on-time payments can help improve credit scores over time. However, carrying high balances or missing payments can harm credit scores.
- Balance transfers: Cardholders may be able to transfer balances from one credit card to another, often at a lower interest rate. Balance transfer fees may apply, so cardholders should carefully weigh the costs and advantages.
- Credit card types: Different types of credit cards cater to different needs, such as cashback cards, travel rewards cards, balance transfer cards, and secured cards. Cardholders should choose a card that aligns with their spending habits and financial goals.
- Credit card debt: Carrying credit card debt may be costly due to high-interest rates and fees. Cardholders should pay their balance in full each month or make more than the minimum payment to decrease the amount of interest they pay.
- Annual fees: Some credit cards charge annual fees, ranging from a few dollars to several hundred dollars. Cardholders should consider whether a card’s rewards and benefits justify the yearly fee cost.
- Credit card APR: The interest rate levied on credit card balances is expressed as an annual percentage rate (APR). APRs can vary by card and may be influenced by factors such as creditworthiness and market conditions. Cardholders should be aware of their APR and consider strategies to reduce interest charges, such as paying off the outstanding balance each month in full or transferring balances to a card with a lower APR.
- Credit card perks: Besides rewards programs, many credit cards offer additional perks such as travel insurance, purchase protection, and extended warranties. Cardholders should review the terms and conditions of their card to understand the full range of benefits available.
Examples of credit cards
- Visa: Visa is a widely accepted credit card brand from merchants in over 200 countries and territories. Visa offers a variety of credit cards with different rewards and benefits.
- Mastercard: Mastercard is another famous credit card brand accepted by merchants worldwide. Mastercard offers a range of credit cards with features such as cashback, rewards, and travel benefits.
- American Express: American Express is a premium credit card brand known for its high-end rewards and benefits. American Express offers a variety of credit cards, including ones with rewards points, cash back, and travel benefits.
- Discover: Discover is a lesser-known credit card brand, but still widely accepted by merchants in the United States. Discover has a variety of credit cards with advantages, including cash back, reward points, and 0% introductory APRs.
Credit cards are a convenient and flexible method to make purchases and manage finances, but cardholders must use them carefully and understand the implications of borrowing money on credit. By understanding how credit cards work and their various features and fees, consumers can make informed decisions about which cards to use and how to use them effectively.
One important thing to note is that credit cards are only suitable for some. If you have a history of overspending or difficulty managing debt, there may be better options than using a credit card. In such instances, it may be better to focus on building an emergency fund and developing healthy spending and saving habits before considering a credit card.
Additionally, it’s essential to be aware of scams and fraudulent activity related to credit cards. Cardholders should never provide their credit card information to unsolicited calls or emails and should regularly review their statements and credit reports for suspicious activity.
Finally, it’s worth noting that credit card terms and conditions can change over time, and cardholders should be prepared to adapt to these changes. This can include adjustments to rewards programs, interest rates, and fees. Staying informed and reviewing your card terms regularly can help you stay on top of these changes and make informed decisions about your credit card usage.