How Do Credit Cards Work?

How Do Credit Cards Work?

Reading Time: 5 minutes

You’ve probably had a friend tell you about the awesome rewards they get on their credit card which helped pay for their trip to Mexico. There are other stories that you’ve heard too. About how credit card debt is taking over people’s finances.

 

These negative repercussions have made you hesitate about getting a credit card. Understanding how credit cards work and how to use them responsibly will help avoid pitfalls like accumulating credit card debt. Then you can reap the benefits and rewards that come with having a credit card.

 

How do Credit Cards Work?

A credit card is basically a type of loan. The bank, called the “issuer” will set a credit limit, which is the maximum amount that you can spend.

 

Your billing cycle is about a month long and you must pay back the balance within the grace period to avoid paying interest. Your grace period is typically about three weeks long. The statement closing date is the last day of your billing cycle and you’ll receive a statement either by email or in the mail, based on your preference, that lists all the charges for that billing cycle.

 

For example, you charge $250 of purchases on your credit card on the tenth day of your billing cycle. Your total credit limit is $1000 so you have $750 of available credit that you can still borrow. You’ll have more available credit when you make a payment.

 

Since your billing cycle is 30 days long, you have 20 days remaining plus another 21 days from your grace period to repay the $250. That’s a total of 41 days to pay back those purchases without interest charges.

 

That flexibility is why credit cards are a popular choice among consumers. However, if you spend more than you can afford, then you will quickly get yourself in a very bad financial situation.

 

What Interest and Fees do Credit Cards Charge?

The interest charges on a credit card is called the annual percentage rate, APR. This is the annual cost of borrowing money on your credit card. You’ll pay this interest rate on the balance of what you didn’t pay during the grace period.

 

Let’s take the following scenario: You have a credit card with a 15% APR, which is about the average interest charged on a credit card. If you carry a balance of $1,000, you’re charged daily interest on that balance. This is computed by dividing the APR by 365 and multiplying the amount you owe. You’ll owe an additional $150 if you keep that balance for a year, hypothetically.

 

Credit cards will require that you make a minimum payment each month to avoid fees and to keep your account in good standing. This minimum amount is generally around 2 to 3 percent of the balance.

 

Other than interest, there are other fees that you might be charged, depending on the credit card you have. Your credit card agreement will list all the fees associated with your account.  Here’s a list of some of the fees that are common:

 

  • Annual Fees – This charge is common on travel credit cards that generally offer more perks and benefits. The fee is charged annually for owning the credit card. The most typical amount that is charged is $100.
  • Balance transfer fees – If you move credit card debt from one card to another, this is the amount the issuer will charge. Some credit cards will waive this fee as an introductory offer to incentive you for opening an account. Balance transfer fees are usually between 3 and 5 percent of the amount of the balance.
  • Cash advance fees – If you use your credit card to withdraw cash like you would a debit card, you’ll be charged this fee. The charge will usually be the greater amount between a percentage of the transaction or a flat amount.
  • Foreign transaction fees – Travel credit cards will usually waive this fee as a perk of having the card. This charge is what you’re assessed if you use your credit card to make purchases in foreign currency. The fee is typically a percentage of each purchase you make so it can add up quickly.
  • Late payment fee – If you don’t pay at least your minimum payment by the due date, you’ll be charged a late payment fee. The fee is normally around $39, which is a pricey mistake!

 

What types of Credit Cards are there?

There are many types of credit cards out there. They can serve different purposes; therefore, certain types of cards are a better fit for certain people. Here is a rundown of the most common types of credit cards that are available:

 

  • Rewards Credit Cards.This type of credit card offers some type of rewards to its cardholders. Cash back, statement credits, and points that can be used for airfare, hotel, etc. are examples. 79 percent of consumers named rewards as the most attractive feature on their credit card according to a TSYS study.

     

    Rewards credit cards are the most popular type of credit card. If you are getting your first credit card, you might not qualify for the cards with the best rewards program. Using your credit card responsibly will help you qualify for credit cards with better rewards in the future.

  • Secured Credit Cards.Secured credit cards require that you put down a deposit upfront to open an account. This deposit also typically serves as your credit limit. Other types of credit cards are “unsecured” and there’s no deposit requirement.

     

    Secured credit cards are ideal for people who are new to credit or trying to rebuild credit. Just like unsecured credit cards, payments on a secured credit card are reported to the credit bureaus. This helps you build credit and qualify for other types of credit cards with more benefits.

 

Why should I get a Credit Card?

Credit cards offer many great benefits as long as you use them the right way. These benefits include:

 

  • Help with building your credit
  • Earn rewards
  • May have additional shopping and travel perks
  • Are more secure than a debit card; Better protection with online shopping
  • Have access to interest-free short term loans

 

To get a credit card, you should look for one that fits your current situation. If you’re new to credit, a starter credit card, student card, or secured card would probably be the right fit. Many issuers will allow you to check if you’re pre-qualified for a credit card offer on their website. Use this feature to see what you might be able to get before completing an application.

 

How do I build Credit using a Credit Card?

 

Credit cards are arguably the best tool to build your credit score. A good score can get you approved for things like mortgage loan with lower interest rates. Landlords, employers, cell phone providers, utility companies, and insurance providers also use your credit score to help determine if they will enter into a relationship with you. Here are some things you can do to help you build credit with a credit card:

 

  • Pay your bill on time – 35 percent of your FICO credit score is based on whether you pay your credit card bill on time. It’s the most important and easiest thing you can do to build good credit. Use features like auto-pay on your account so that you never miss a payment.
  • Don’t’ use too much of your balance – Ideally, you want to keep your balance below 30 percent to build credit. Charging more than that is a red flag to creditors and may indicate that you’re borrowing more than you can afford.
  • Don’t close your accounts – Even if you stopped using your first credit card months ago, don’t close it. Otherwise you lose out on that credit history. It also reduces the average account age, so it’s actually better for your credit score to keep it open.
The Future of Credit Cards: Is Plastic Disappearing?

The Future of Credit Cards: Is Plastic Disappearing?

Reading Time: 4 minutes

Before plastic credit cards were invented, the concept of credit was around for centuries. With today’s modern society and technological advancements, credit cards have come a long way.

 

 

How Did the Credit Card Start?

Credit cards got their start way before you were born. In fact, they got their start before the internet, planes, automobiles, trains, and the lightbulb. They go back before the French Revolution, and Benjamin Franklin discovered the power of lightning. They even go back before the age of Victorian England, the printing press, and Shakespeare. So just when did this credit system start?

 

The Early Beginnings of Credit

Historic records provide evidence of a written credit system that goes back to the ancient Code of Hammurabi. Named after the ruler of Ancient Babylon from 1792 to 1750 B.C., this code provided an example of a written credit system. There were rules for lending and paying back a loan with interest. There were even rules for how interest rate worked. According to the code, a loan served as a financial agreement between one borrower and one creditor or merchant.

 

The Rise of Credit Cards

In the early days of the “Wild West,” owners of general goods stores often extended a line of credit to their customers who were farmers and cattle ranchers. Because these men only got paid after the harvest or when their herd sold at the market, the store owners allowed them to purchase on credit and pay their bill when profits came in.

 

Fast forward to the 1900s and the rise in travel, commerce, and an economic boom. Larger hotels and department stores started issuing paper cards to valued customers they could trust to pay them back. By 1950, Diners Club launched its first general merchandise charge card. They were issued to well-off customers and used it for travel and entertainment expenses. This credit card system created by Ralph Schneider and Frank McNamara required customers to pay off the balance each month in full, creating our modern-day credit card system.

 

In 1958, Bank of America launched its general credit card called the BankAmericard. It came with a whopping $300 credit limit and was the first of its kind of offer revolving credit, giving people the option to carry over a balance.

 

Credit Cards and Modern Technology

By the 1980s, cards transitioned from paper to plastic with a magnetic stripe on the back. This strip allowed the credit reading to be taken by special computer equipment. In the 1990s, they continued to evolve and were soon embedded with computer chips called EMV smart chips. These chips allowed for encrypted, two-way authentication between the merchant’s credit card terminal and a payment processing network.

 

history of credit cards

 

What is the Future of Credit Cards?

With the history of credit solidly in place, let’s turn our attention to the question of their role in the future economy. What will be their place? Will there be some other form of credit option, or are the plastic cards in our wallets here to stay?

 

Cashless Transaction

These days, everything we purchase from the grocery store to the movie theater is likely bought with a credit or debit card, or alternative mobile wallet, cash-sharing app, or cryptocurrency. There are plenty of alternative ways to pay for your purchases these days, including:

PayPal Credit: PayPal has a line of credit in addition to providing a platform to pay directly.

Cryptocurrency: The most well-known currency is Bitcoin, but there are others, including Litecoin and Ethereum.

Prepaid Cards: These function like debit cards but preloaded with cash.

Mobile Wallets: The most popular options are Apple Pay and Google Wallet. These link directly to your bank accounts, debit or credit cards, allowing you to access all financial resources without a card physically present.

 

More Security Features

Fraud prevention is one of the top concerns when it comes to credit, credit repair and debit cards. As technology evolves, features are added to increase security and protect the purchaser. However, the security system in place is far from complete. In the future, you can expect credit card companies to incorporate AI to detect and fight fraud. 

 

Artificial Intelligence in Credit Cards

AI technology is exploding in its applications, uses, and intelligence. Expect that AI will soon be employed to detect and fight fraud, in addition to providing customer-focused services. Credit AI will likely resemble something close to Amazon’s Alexa and manage payments, identify spending patterns and trends, make suggestions for purchases, and remind you about upcoming payments.

 

Contactless Payments Through Smart Phones

Numerous banks are rapidly adding features to their apps that allow their customers to control credit and debit cards through their app. Consumers currently can lock their cards, control spending limits, report lost cards, and alert the company to potential fraud the minute it happens. Eventually, the use of smartphone apps for credit and debit cards could go the same way as Apple Pay or Google Wallet and become a completely contactless form of payment with no physical card required.

 

 

Will Plastic Credit Cards Disappear?

Technology is rapidly evolving, and both consumers and merchants alike are focusing more attention and energy into online, app, and contactless payment. However, with the advent of Google Wallet, PayPal, Square, and CashApp, major credit cards have received another platform to conduct business. Far from hurting credit card companies, apps, and online methods have made it easier to gain customers and provide credit to people in nearly any situation. Major credit card companies such as MasterCard, Visa, and American Express have all come up with a mobile payment platform for their customers.

 

Though consumers might start paying in varying ways beyond using the physical credit card, they’ll still be using credit extended to them by the companies that issue cards.

Credit cards have come a long way from being tied to a single merchant. Today, credit is extended from major companies to people of all ages and economic status. The future possibilities of credit cards are endless.

 

 

Common Credit Card Myths Debunked

Common Credit Card Myths Debunked

Reading Time: 5 minutes

Accessing the internet from our smartphones, tablets, and laptops – virtually anywhere across the globe – has certainly made our lives easier. 

 

With seemingly endless information available on the Web, however, comes a great deal of inaccuracies, including everyone’s favorite buzzword, “fake news.” 

 

There’s a great deal of misinformation out there surrounding credit scores and credit cards. Believing some of these myths could wind up costing you a hefty amount of unwanted fees and hurt your overall credit score. 

 

In order to put your best financial foot forward, it’s vital to do some research and know all the facts. To help you separate truth from fiction, here are some common credit card myths debunked.

 

 

Legendary Misconceptions About Credit Cards 

Myth: Credit cards are dangerous, and you should avoid them (or else…)

The truth is, you’re way better off using your credit card vs. a debit card when paying for gas, groceries, etc. 

 

That’s IF you’re fiscally responsible and can use your credit card wisely (a.k.a. spending only what you can afford to pay off each month). 

 

Best credit cards are a vital and effective means for building your credit history & boosting your credit score. Plus, most companies now offer cash-back, airline miles, signup bonuses, and rewards programs where you can trade points earned for a whole bunch of goodies. 

 

Mortgages, car loans, credit cards for students and other lenders are looking to evaluate your credit history. Without one, you likely won’t qualify for a loan unless you bring on a co-signer.

 

 

Myth: Checking your credit score will cause your good credit to plummet

A simple check through sites like Credit Karma won’t negatively impact your score. Your credit score is only affected when a “hard” inquiry is made. 

 

A hard inquiry refers to anytime someone requests a copy of your credit report as a part of your application for a loan, credit card, or other forms of credit. Checking on your own is considered a “soft” inquiry and will not have any effect on your credit score.

 

 

 

Myth: Close accounts you’re not using…why would you leave them open!?

Outrageous! The fact of the matter is, leaving your old credit accounts open can provide a number of benefits. 

 

By keeping accounts open:

You’re ultimately increasing the length of your personal credit history, which is one of the main factors used to calculate your credit score. 

 

Perhaps even more importantly, when you accumulate a large pool of credit that is not actively in use, it’ll help keep your credit utilization ratio low.

 

credit card myths discussed

 

Myth: Your credit report is 100% accurate, 100% of the time.

That’s like saying the weather forecast is 100% accurate all the time, which we all know it isn’t. Did you know that as many as 1 in every 5 Americans have incorrect information on their credit reports? 

 

There could be an inaccurate balance showing, a missed payment posted that you actually made on time, or an account on your report that you’re not liable for. 

 

The good news is you are legally entitled to request a copy of your credit report from each of the three main credit bureaus once per year. 

 

And, it’s highly recommended that you do so. This allows you to check for any inaccuracies and clean up false information that may be hurting your overall credit score.

 

 

Myth: Missed one payment? Don’t sweat it. It’s no biggie.

Wrong! The reality is, your payment history is the single largest factor used to calculate your credit score. Here’s the scary part: one missed payment (yes, just one) can remain on your credit report for up to seven years. 

 

What’s more, it could cause your score to drop by more than 100 points short term. Seriously, can we get Daniel Powter over here because this is this perfect moment to hear him sing, “you had a bad day.”

 

 

Myth: You’ll have the same APR from when you first signed up for your card

Sorry to be the bearer of bad news, but your credit card interest rate can fluctuate throughout your ownership of the card. 

 

People tend to overlook the fact that they were given an introductory APR when first signing up for their card. Some credit lenders, for example, will offer 0% APR for 12 months as an incentive to sign up with them. After a year, however, if you still carry a balance, or continue using that credit card, you’ll begin paying interest on it. 

 

what you should know about credit cardsMoving beyond introductory APRS, interest rates can also change due to late payments. Many card issuers will tack on a penalty APR, which is typically around 30%.

 

Another way your interest rate can change is if your APR is attached to the prime rate. 

 

In this instance, your issuer would supply you with a variable interest rate that would fluctuate in proportion to the prime rate. This is the interest rate that banks will offer to their most creditworthy clients. 

 

So:

Ultimately, this area is out of your hands. 

 

Lastly, if your issuer considers you a high risk, they may decide to raise your APR as a way to protect themselves against missed payments or high balances.

 

 

Myth: Maxed out your card? Good thing there’s no penalty for that.

Incorrect! Everything has consequences. There’s a little something called credit utilization that comes into play here. 

 

Credit utilization is the percentage of available credit you use each month, and it’s something that credit bureaus not only track but factor into your credit score too. 

 

By maxing out your credit card and using 100% of your available credit, it communicates to creditors that you’re potentially a high lending risk. 

 

This not only negatively impacts your credit score, but it can also result in higher interest rates and a tougher loan approval process should you apply for one in the future. Experts often recommend using a maximum of 30% of your available credit month over month. 

 

 

Well, there you have it! We have just debunked several common credit card myths. Now that we’ve put those to rest, you are equipped with the knowledge needed to properly use your credit card for building your credit and manage your finances. A little retail therapy is good, but just don’t get in over your head! 

 

Being financially responsible can greatly improve your life and help you achieve the future you’ve always envisioned for yourself. 

Credit Cards & Interests Rates: How One Affects The Other

Credit Cards & Interests Rates: How One Affects The Other

Reading Time: 5 minutes

Having good credit and a good credit score is important to your financial well-being and your life. Having credit allows you to purchase things you need, such as homes and automobiles and can even help you get an apartment or a cell phone contract. Your credit history and your score affect your ability to borrow money, and it affects the interest rate you’ll pay, which can make it easier or harder for you to pay off your loans. 

 

In this article, we look at why having a good credit score is important, and how your score affects your interest rate.

What Is Your Credit Score?

Your credit score is a number that’s derived from your credit history. This number tells lenders how much of a risk you are when deciding to lend you money or extend lines of credit to you. 

 

Since this number is one of the main factors taken into consideration, you need to work hard to maintain a good credit score, because having bad credit lessens the chance you’ll be able to borrow money, and increases the chance of borrowing money with unfavorable terms. 

 

How Companies Determine Credit Scores

The information in your credit report is what’s used to determine your credit score, and it’s vital you understand what information credit reporting agencies consider so you can take steps to improve your score if needed.

 

There are 5 pieces of information that determine a credit score: Payment History, Amount Owed, Credit History, Types of Credit, and New Credit. 

Payment History

Your payment history comprises the largest percentage (40%) of your credit score. The information a credit reporting agency uses to factor in payment history is the number of accounts you have versus how many payments you’ve made on time. 

 

Also:

 

The number of accounts that are 30 days or more delinquent factors into this. 

 

Reporting agencies take into account whether you’ve filed for bankruptcy or had an account go into collections. Making every payment on time is the most important thing you can do to maintain your good credit and to build it up if it’s not where you want it to be.

Amount Owed

The next factor that goes into your credit score (30%) is the amount you owe on your accounts. The credit reporting agency looks at your spending habits and the amount of money you owe to determine if making payments is sustainable should you encounter financial hardship. Factors that determine the amount owed are the number of accounts in which you have a balance, how much credit you’ve used, and how much you owe on all of your cards and loans. 

 

As with making on-time payments, paying down debt goes a long way to improving your credit score and is easy to do if you pay more than the minimum payment every month. 

Credit History

How long you’ve had credit cards and other forms of credit is another factor that goes into your credit score. For example, if you have, say, five years of on-time payments with a credit card, it looks better than if you only had an account for a few months. The longer your credit history, the better the risk you’re seen as for lenders

 

Therefore, it’s important you keep your old credit cards instead of cutting them up. Use them for small purchases to keep them active and pay off the balance at the end of the month to maintain a long credit history.  

Types of Credit

Lenders like to see a variety of credit accounts, which is why you should have loans, retail cards, and bank cards instead of only credit cards. Having more variety in your types of credit shows you’re a well-rounded borrower. 

New Credit

The last bit of information that credit reporting agencies consider when determining your score is the new lines of credit you opened up recently. Factors in this include how long it’s been since you’ve opened a new account, the number of ‘hard pulls’ to your credit you had in the last year, and how long it’s been since you last had an inquiry into your credit report. 

 

interest rate for credit card

Credit & Interest Rates

Now that you know about what makes up your credit score, let’s look at how that score affects your interest rate. 

Lenders & Numbers

So, when you apply for credit, your lender looks at the credit score given to them by one of the major credit reporting agencies. Credit scores usually range from 300 to 850 and the number that comes back to the lender affects the interest rate they’ll offer.

 

A high score tells the lender you’re low risk and that you’ll most likely make payments on time and won’t default on the loan. This means you’ll usually get a lower interest rate, and some lenders may reduce the amount you have to put down for a mortgage or an auto loan. 

 

However, lower scores (usually below 620) means you’ll probably get a high-interest rate or may not get a loan at all. Many lenders look at scores above 670 to be good, so if you’re below that, you’re better off improving your score before you apply for a loan. 

 

Building Your Score

Let’s say your score is less than perfect, and you want to get a mortgage or car loan. As mentioned, you’re better off improving your credit score before applying for a loan to get better terms and here’s how to do that.

 

  • Make your payments on time. Even if you’ve missed in the past, start making them on time every month from here on out.
  • Reduce the credit to debt ratio to be 30% or lower.
  • Pay off your high balances as quickly as possible; make more than the minimum payment to do this.
  • Get a copy of your credit report and make sure there are no errors that can drive your score down.
  • Get help from a credit counselor to help rebuild your credit.

 

Many people get into trouble with credit because they don’t understand how it works. If you can avoid it, don’t carry over balances from month to month. Be smart about using your credit, make your payments on time and you should have no trouble when it comes time to get a mortgage or loan. 

 

 

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