This week, we embark on a new personal finance series of articles about that piece of plastic found in our wallets that we can’t seem to leave home without. I’m talking about our credit cards, which allow us to purchase things on the spot, over the phone or online without the need for taking out cash.
The credit card is a wonderful tool that has changed the landscape of our modern economy. In countries like the United States, the credit card is the lifeline for most people as they discourage needing to carry cash around and do all purchases on their plastic cards instead. How does it work and is it really feasible to just rely on a credit-based lifestyle?
The credit card and the digital iterations of such have been favored because of its convenience and its security. The credit card though for all its convenience-rich features can also mean financial trouble if it isn’t utilized in the right way. The objective of our next series of articles will be to see how credit cards work, look at the pros and cons of using it, and life hacks at how to maximize your credit card and even use it to your personal financial advantage.
What is a Line of Credit?
A credit line is actually an amount extended to a borrower by a financial institution like a bank or credit union. A credit card product is essentially a line of credit which you prove by the plastic card that you carry around or in today’s times with the credentials given to you by the bank, i.e. the credit card number and credit validation code, sometimes a method of identification is also needed to prove that the person authorized with the credit line is actually you.
Credit Lines and Credit Cards
When you use your credit card to purchase that shiny new laptop or to buy plane tickets to your dream vacation, you are essentially using the money the credit institution lent you. The credit card issuer pays the person who sold you the product or merchant and then waits for your payment for the money they lent you. The line of credit that has been lent to you is represented by your credit limit on your credit card.
How Do Credit Card Companies Earn?
As lofty and as noble as what they are doing for you sounds like these companies don’t lend you that money for free. Just like with a bank loan you have to pay for the opportunity cost or price of using the credit that was lent to you. Just like a loan, the price of credit is represented by the annual percentage rate or APR. The APR includes the interest rate, mortgage broker fees, taxes and other costs associated with lending you money. For credit cards, the APR is normally added on the amount you charged after a certain period agreed upon by you and the credit card company. So for example, if you bought a canoe for $1,200 and you pay it back in full 15 days later, you won’t be charged with interest for this because you paid the company back before your loan matured. However, if you pay after your agreed period, say for this example, you paid 45 days later, you will be assessed with the APR that applies to the period covered.
This makes it essential to know how to properly utilize a credit card and exert a discipline of avoiding gathering too much debt in it that may result in extremely high interest rate payments. Credit card companies also charge certain fees that are associated with the terms of your agreement. Annual fees are normally very common, as it is the cost of allowing you the privilege of using their credit product. Late fees, over limit fees, foreign currency fees are among some of the other fees the credit card may charge you for.
Overall, credit cards are something very essential for the convenience in daily living, it provides you with an emergency measure when needed and allows conveniences like online shopping or guaranteeing a rental of a major item like a car or boat. Credit cards also positively or may negatively affect your credit score so if you can properly manage it, you’ll need one as you start out your career or while you’re in college.
Our next articles will help you with these as we aim to provide you with the advantages of credit cards.