A credit card is essentially a loan. When you use your card you are borrowing money from the credit card company and you will have to pay back the money you borrowed. After making purchases with your card you will receive a monthly statement specifying the amount owed. You must pay at least the minimum amount due or you can pay in full. Credit card companies charge you interest on any unpaid balance after the grace period.
The over-use of credit cards is a major reason why so many individuals have too much debt, and why bankruptcy rates are high. Consumers are constantly bombarded with offers from credit card companies, offering various incentives and interest rate options.
Before you accept one of those preapproved credit card offers you find in your mailbox, make sure you understand the differences between the types of credit cards and the terms and conditions that will affect your costs.
There are several types of cards that are referred to as credit cards, but they don't all work alike. Bankcards include Visa, MasterCard and Discover. There card companies allow you to make purchases up to a preset credit limit ranging from $500 to $10,000 or more, depending on your income and credit history. You can pay the balance in full each month or the minimum required by the card company or anywhere in between.
Charge cards (also called travel and entertainment cards), such as American Express, require you to pay the entire balance due each month. They have no preset credit limits but if you are late with your payment, you may be charged interest or have the use of your card blocked. There is usually a annual fee for these type cards.
House cards allow you to make purchases at a particular chain of stores such as department stores and gas stations, and make monthly payments, including interest charges.
Gold and Platinum cards include extra perks such as collision coverage when you rent a car, extended warranties beyond the manufacturer's warranty on certain items, travel insurance, discounts, and other benefits. These cards usually have a higher annual fee than the other type cards.
Most credit card companies require you to be over 18 years old, have a verifiable source of income that meets the minimum income required for the card, and have a bank account in your name.
Annual Percentage Rate (APR) - The amount of interest assessed on an outstanding credit card balance.
Penalty APR - A much higher, punitive interest rate that credit card companies may apply to cardholders who have exceeded their credit limits, made one or more late payments, or are otherwise in "bad standing." Penalty APRs are on average about 52% higher than regular APRs.
Credit Limit - The maximum amount of money a consumer may borrow from a credit card company. Credit limits are set based on the consumer's credit history.
Cash Advance - An immediate cash loan from a conumer's credit card account. Cash advances may carry a higher APR than purchases and are often assessed transaction fees.
Balance Transfer - At a cardholder's request, credit card company A will pay the balance the cardholder has with company B, and the balance will then be put onto the cardholder's account with company A. Consumer's usually transfer balances when applying for a new card to take advantage of low introductory APRs. Balance transfers usually incur transaction fees.
"Pre-Approved" - This term is misleading and does not mean the consumer is guaranteed to receive the card for which they applied for, or any card at all. It merely means that the consumer was chosen to receive the offer because they met some initial criteria of creditworthiness.
Grace Period - The time during which a transaction does not accrue interest. Grace periods range from 0-30 days, with an average of 23 days, and they often apply only to purchases, not cash advances or other transactions. On most cards, grace periods only apply if the previous month's balance is paid in full and on time.
Transaction Fee - Cardholders are nearly always assessed additional fees for transactions other than purchases (such as cash advances). The fee is usually a percentage of the transaction, but a minimum fee may apply.
Advantages of Credit Card Purchases
Credit cards can protect you if a purchase turns out to be a lemon. Dispute the charge before you pay your credit card bill. Notify the credit card company, in writing, of the transaction, the amount of the charge and the name of the merchant.
Credit cards are now better than traveler's checks for most trips overseas. Aside from the cards' convenience, they can save as much as 6% on exchange costs.
Pay a credit card bill in full before the grace period runs out, and you get, in effect, a free loan. The closest you'll come to free money.