What is a Credit Card? How does a Credit Card Work?

From paying bills to maintaining credit scores or taking loans, a credit card is a very useful tool. A credit card enables the cardholder to pay a merchant for services or goods even if he/she does not have adequate balance in the account.

So, you can use the card for buying something and then pay the amount later. Bank allows its customers for purchasing on credit and generates a statement at regular intervals with details of the transactions made by the users.

It is like a short time loan given by the bank. At the same time, it lets you reuse the loan amount repeatedly instead of giving a full-time loan.

How Does a Credit Card Work?

Users can use credit cards while purchasing a new commodity by tapping, swiping, inserting it into a suitable payment terminal. Also, they can use their credit cards by entering the account number of the payee and transact online. You can even use mobile wallets for processing your credit cards.

When you purchase anything on a credit card, it will show “pending” on your account balance. Purchases mainly take up to five to seven days to post. Then the purchase amount will be added to your bank’s total balance.

In addition to this, you will receive a bill every month that will comprise all purchases in the last twenty-seven to thirty days. Every month, your bill is due on the same date. 

You also have a grace period (a minimum of twenty-one days from the end of the billing cycle) to repay the balance. But if you fail to make the payment in between the grace period, then it will incur charges with interest.

The main difference between a regular loan and credit limit is that credit card is more reliable to the users. So, the credit limit is available once you pay the balance on the card. You can also continue borrowing against your credit limit if your past transactions were fully resolved.

Common Terms for Credit Cards

Before using credit cards, you should know the terms to use it. Let’s get familiar with these terms.

  • Annual Fee:

This fee is charged from the credit card holder on a yearly basis. But some banks do not impose this charge when customers apply for a credit card. They might waive this fee for the first year.

  • Credit Bureau:

There are few companies or banks that track the details from your lending accounts and assemble it into your credit report. These details then help you to create credit scores.

  • Balance Transfer Fee:

The interest rate that is applied to transfer balance is known as the balance transfer fee. This fee can be greater than or equal to the purchase APR (annual percentage rate).

  • Available Credit:

The available credit limit is calculated as the difference between the current balance and the credit limit. This is to know how much is left for spending before striking your credit limit.

  • Payment Due Date:

This due date is about 20-25 days within which you need to make the payments to clear the credit card balance. So, you can deposit the minimum payment to your card while ordering anything to avoid the late charges.

  • Balance Transfer:

This allows users to transfer the balance in their accounts from one credit card to another. While you are moving to a card with a lower interest rate, balance transfer helps you to do so.

  • Grace Period:

If you are using credit cards, then you should know about the grace period. It is the number of days between the due date of your payment and the end of the card’s billing cycle.

  • Principal:

The principal is a portion amount in the card that comes from making regular purchases. If you maintain a minimum balance on your card every month, then the principal will be added to your account.

  • Total Unbilled Amount:

This amount is the sum of all retail transactions, both credit as well as debit, made by you after the last statement was generated.

  • Cobranded Card:

It is the type of card that is sponsored by a specific bank or company like an airline, retailer, hotel, and so on. Sometimes, this card offers specialized perks with the partner brand. Users also get some cashback when they purchase anything using a co-branded card.

  • Credit Limit:

It is the sum of the amount the user can charge to a credit card. When you open a credit card account initially, you can get some credit limit. But you can request to the bank or the company to increase the limit later.

Few Benefits of Using a Credit Card

If you are disciplined with your spending, then you might find your credit card very useful. There are many advantages to use a credit card to make your life easier.

  • Easy to Carry:

Credit cards are easy to carry and easy to use for customers. In recent times, credit cards are more or less accepted everywhere.

  • Get your Money Back:

Unfortunately, if your credit card gets stolen, you can contact the provider and tell them to block your card. In case it is used fraudulently, then there is a higher chance of getting your money back.

  • Buy Now Pay Later:

Credit cards allow you to buy things at the time of requirements and pay later. It means you can purchase anything using your credit card even if you have a shortage of money. At the same time, you can pay it monthly or quarterly.

  • Cashback and Rewards:

Users get rewards and cashback when they make payment using their credit card in the shopping mall, or anywhere else.

  • Signup Bonus:

Many credit cards offer an attractive signup bonus when the users sign up their card for the first time. But remember that, not all banks or companies give good bonus points. So, choose the correct one for you to avail of the signup bonuses.

  • Exclusive Discounts:

Selected cards offer exclusive discounts at retail, dining, travel merchants as well. This discount is sometimes added as a bonus point to the card holder’s account.

  • Several Insurances:

Most of the credit cards come with multiple consumer protection features including car insurance, product warranties, travel insurance, health insurance, etc.

  • Useful in Emergency Cases:

Credit cards are too useful for us, specifically in emergency cases. In some urgent cases, you have to pay a large amount of money. In those situations, credit cards can help you to get rid of such problems.

Cons of Credits Cards

Besides, the benefits of credit cards, there are some disadvantages to use it. Let’s take a look at the cons:

  1. If you maintain a fair balance every month, then you have to pay interest charges. In that case, interest rates are as high as 22% APR. But, if you want to close your account, you will have to pay a large amount of money as well.
  2. If you missed any repayments of your credit cards, then it can create a negative impact in the future. This happens mostly when you are applying for another loan.
  3. You have to maintain a minimal annual fee in your account if you are using credit cards. Sometimes, it can be a headache for the card users and force them to close their accounts.
  4. All credit cards are designed for different purposes. But in most cases, these cards are expensive when it comes to charges and other fees. Also, it depends upon the users who are using the cards and what their purpose is.
  5. Using credit cards can lead to overspending in many cases. If you are not aware of this, it can lead to unexpected debt.
  6. Sometimes, there can be fraudulent cases as well. So, if the cards are left somewhere or stolen, the hackers can easily steal the money and your identity.

What Are Credit Card Charges?

If you are using a credit card, you should be aware of several charges that may be applicable to you.

Interest Rates

There are situations when you forget to pay the credit card balance at the end of the month. Also, you may not in the zero percent introductory period. Then you have to pay interest on the entire amount of your loan balance.

If you are a new customer, you may get an introductory rate once you have purchased a credit card. You have to check the interest rate if the introductory period gets over.

In case, you want to transfer money from one bank to another, then you might be charged a 3%  interest of that amount.

Late Payments

In case you do not make payment after the monthly deadline of your statement, then you have to pay a late payment fee. If this continues for three times, it might have a negative impact on future credit applications.

Minimal Credit Card Payments

Once you have applied for a credit card, you have to pay a minimal amount of money and maintain it throughout the loan process. So, it is recommended to repay the maximum amount during the initial period.

Cash Withdrawals

Debit cards and credit cards, both work differently at cash machines. If you prefer to use credit cards, then you have to pay a fee every time you withdraw cash from your account. Otherwise, you will get a warning of extra amount deduction when you use it in the machine. Hence, it is advised to avoid withdrawing cash on the credit cards.

Credit Card Cheques

Just like a normal cheque, credit card cheque is also a blank cheque. Instead of fetching any money out of your bank account, a certain amount goes to your credit card bill. Besides, if you use credit card cheques, you will be charged a handling fee. This can be of a maximum of 2.5 percent of the amount you are going to purchase.

For example, if you purchase a thing that costs £1000, then you have to pay £25 more than the amount. In most cases, if you use a credit card cheque, the interest is charged from the day the cheque was used. 

The credit card cheques are quite expensive and treated as a cash withdrawal. Also, the interest rate is high as compared to the others.