Credit Card Definition And How It Works

savings account
Photo credit: Unsplash

A Credit card is a metal card or small plastic card issued by financial companies which allows you to make purchases either online or at the brick-and-mortars. It can also allow you to borrow money up to a fixed limit that is offered by your credit card issuer. This fixed limit of borrowing is known as your credit limit.

The credit card issuer allows you to take as much of the limit as you want at any given time rather than giving you the full loan in cash. So that you can borrow always borrow again as you pay for what you have borrowed.

What is a credit card?

Credit Card

A credit card is a small rectangular piece of metal or plastic that is issued by your financial service companies or banks which allows you to borrow funds that you can use to make purchases or pay for goods and services with merchants that accept payments through your cards.

A condition imposed by the credit card is that any borrowed money must be paid back with all its interests and any agreed additional charges in full or over a specified period of time. A good example of a credit card is the Chase Sapphire Reserve.

Your credit card issuer may also grant you a separate line of credit which allows you to borrow more money in form of cash advances that you can easily access through bank tellers, credit card convenience checks, or through the bank tellers.

Such advance cash may typically have different terms such as high-interest rates or no grace period at all. Your credit rating will determine the amount of money you can borrow, as pre-determined by the issuer.

Many businesses accept credit cards payment from customers for making purchases or buying goods and services.

All about credits cards

Credit Card

A higher annual percentage rate is usually charged by credit cards against any other forms of consumer loans. Unpaid balances accrue interests and this interest is imposed and charged to the card almost a month after the purchase has been made, except there is an introductory offer in place which has 0% APR for a specified period of time after you open your account or unless an unpaid balance from previous month has been carried forward – in which case, the grace period is not granted for new charges.

Credit card issuers must, by law, offer at least 21 days before any unpaid balances start to accrue interest, either daily or monthly. If the balance is not paid quickly, the former translates into higher interest charges. If you want to transfer your credit card balance to new cards, this is very important to know.

Your savings can be nullified from a lower rate if you mistakenly switched to a daily accrual card, from a monthly accrual one. People with bad credit histories can seek a secured credit card, this requires a cash deposit and allow them to get the corresponding line of credit.

How do credit cards works?

Credit cards typically work by inserting them into a card reader so as to pay for any goods or services bought at the brick and mortar retailers. Your billing zip code may also be required. If you are using the card online, your full info (names and billing address), the card number, its expiration date, and the security code at the back of the card will be needed.

When you enter your card info to make purchases, the credit card terminal of the merchant contacts your credit card issuer and asks if the credit card is valid and has enough credit available. Your credit card issuer then relays back a message with the status of the transaction, whether it is approved or declined.

The transaction may be declined if your credit limit has been reached or your card has been deactivated due to suspected fraudulent activities.

Card issuers may typically deactivate your card and get in touch with you if unusual purchases have been made by you, this doesn’t mean your identity has been stolen.

If you change your location, say maybe your travel to another country, your card may be deactivated by your card issuer until they have a confirmation that you are truly the one making the purchases.

Types of credit card

Credit Card

Popular credit cards like Mastercard, Visa, American Express, and Discover are typically issued by credit unions, banks, and other financial institutions.

Customers are attracted by many credit cards by giving incentives such as hotel room rentals, airline miles, cash back on purchases, and gift certificates to retailers. These card types are known as rewards cards.

Many national retailers also issue a branded versions of credit cards so as to generate customer loyalty, with the store name boldly emblazoned on the front face of the cards. Store cards can only be used for purchases from the issuing retailer alone, which may offer the consumers gifts such as promotional notices, special discounts, or special sales. Although it is very easy for consumers to qualify for such cards than to qualify for major credit cards.

Co-branded cards with Visa or Mastercards can also be issued by big retailers to be used anywhere and not just in their stores alone.

There are some cards where the cardholder will have to make a security deposit so as to secure the card, these types of cards are called secured credit cards. Such cards offer a credit line that commensurates with the secured deposits, which are usually refunded after the cardholders have demonstrated responsible and responsible use of the card over a specified period of time. People with limited or bad credit histories often seek this kind of card.

Just like a secured credit card, we also have a prepaid debit card which is a form of a secured payment card, where the money available is matched to the bank account linked with the card. Meanwhile, collateral or security deposits aren’t needed for unsecured credit cards. These types of cards offer lower interest rates and higher credit lines in contrast to a secured card.

How to build credit history with credit cards

When cards are used responsibly, they can help consumers to build a positive credit history and also provide a way to eliminate the need to move cash around while encouraging online purchases. Since credit cards report major use of your cards to credit agencies, cards that are used responsibly may help build a strong credit score and generally increase your credit line, and can also help in upgrading to a regular credit card in the case of secured credit cards.

How your credit line works

Whenever you make a purchase and pay with your credit card, the credit available on the card goes down by that amount.

For instance, if you have a $500 credit limit and a purchase of $75 is made, you’ll have an available credit of $425, it means you are owing to the credit card company $75. If you borrow another $80 before paying back the $75 you earlier borrowed, it means you’ll be owing to the bank a total of $155 and have an available credit of $345.

When your loan is paid down, your credit limit becomes available again, this is what differentiates credit cards from regular loans. Assuming you started with a balance of $0, if you pay back the $155 that you are owing to the bank by your credit card due date, you will have $500 available credit again, in most cases.

The process of spending up to your credit limit can be repeated and repaying the balance as often as you can to keep your available credit intact, provided the terms and conditions of the credit card are kept.

Your credit limit can continue to be borrowed over a period of time, this is why credit cards are often called open-ended accounts or revolving accounts.

How do credit card interests work?

A certain amount of time is given to you by the credit card issuer to pay the total amount of the money you borrowed before interest is charged. The space of time given before interest is charged is referred to as the grace period, which normally is between 21 to 25 days.

If the full balance is not paid before the grace period ends, a finance charge or fee is added to your balance, based on your interest rate and outstanding balance.

Your interest rate is the yearly rate that you pay for borrowing money on your credit card, and this is generally based on your credit history, market interest rates, and the credit card type that you own.

How does credit card minimum payment work?

Your balance should be paid in full on or before the due date so as to avoid interest charges. Although, the credit card issuers don’t require that all you owe must be paid at once. The minimum payment must at least be paid by the due date in order to avoid a late penalty fee.

How your minimum balance is determined varies from one credit card issuer to the other, however, yours can be found in your credit card terms.

In order to avoid late penalty fees and maintain a good credit history, the minimum payment should be month on time every month. This is the slowest and most expensive way to have your credit card balance paid off. But when you can, it is ideal to pay the balance in full.

Sharing Is Caring - Spread the love