Credit Card | Definition

Credit cards are a great way to help finance purchases if you are a responsible spender. But if you can't pay back your credit card bill, then it can lead you into a cycle of debt.

Credit cards have become a common form of payment these days. In fact, some businesses won’t let you pay with cash. So what is a credit card anyway, and how does it work? What are the benefits and drawbacks of using one? 

A credit card is a line of credit from a bank or lender that allows you to make purchases flexibly directly at a business, transfer balances to your card, and get cash advances. However, unpaid credit card balances are usually charged high-interest rates. Credit cards mostly take the form of small rectangular pieces of metal or plastic which hold your account information.

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Getting Approved for a Credit Card

Since a credit card is a line of credit, meaning the bank is lending you money, they determine your creditworthiness before issuing you a credit card. Therefore, your credit rating will not only determine if you receive a credit card but also your interest rate and other terms.

The better your credit rating, the better terms, and rates you will receive on your credit card.

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Whose Money is Being Used?

You are not paying for that item whenever you swipe a credit card; the bank or lending institution is paying the merchant. Instead, you promise to pay the bank the amount you borrowed by a particular date, plus any interest that accrues.

Who is Involved in a Credit Card Transaction?

A credit card transaction involves four groups. First, you decide to make the purchase. Second, the business you are buying from is involved. Every time you purchase with a credit card, the merchant is charged a small processing fee.

This processing fee comes from the third group, the financial services company or card company such as VISA, MASTERCARD, American Express, etc. These companies aren’t lending you the money. They are simply the middleman making sure everything runs smoothly. When you swipe, they check with the fourth group, the bank. The bank lets the credit card company know whether you have funds available for the purchase. The bank then comes to you at the end of the month and asks you to pay them in full or pay interest.

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Different Types of Credit Cards

Credit cards can be useful since there are many different types. For example, there are student credit cards with a 0% intro APR offer. Also, there are travel credit cards, business credit cards, and secured credit cards. These credit cards offer benefits, and some may charge an annual fee. 

Benefits

Credit cards are beneficial for several reasons:

• You don’t have to carry cash on you.
• You are protected against a stolen card.
• You often get rewards for using a credit card, sometimes very significant rewards.
• You don’t have to pay the money immediately.
• Protection against fraud.

Drawbacks

Credit cards can be detrimental for several reasons:

• High interest rates with low minimums lead to lots of interest payments and debt.
• It is easy to lose control of your spending when you aren’t using cash.
• Misuse of a credit card can ruin your credit score.

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Credit Card Tips

• To avoid interest payments, pay off your credit card in full each month before the billing date.
• Track your spending so you never spend more than you can pay back.
• Rewards are always less than interest, so don’t use a card just for the rewards.

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