Wondering how a credit card works? A credit card agreement is a legal financial agreement between an issuer, typically a bank or credit union, and a cardholder, commonly a consumer. The agreement is for a line of credit that the issuer extends to the cardholder for purchases to be made with various merchants worldwide. The credit card itself is simply the tool that allows the holder to act upon this agreement.
In addition to a line of credit to make purchases through merchants, the agreement can also be used for a cash advance by the cardholder. In return for the line of credit and cash advances, the issuer receives various payments from merchants and oftentimes collects money from the cardholder as well for various fees and interest that accrues on any unpaid balances. The fees and applicable interest are outlined in the credit card agreement.
How to Obtain and Use a Credit Card
Credit cards can be obtained through a variety of methods. Sometimes you can apply for one at a specific merchant, other times you can respond to a credit card offer received by mail. Credit cards can also be applied for on the internet. Applying for a credit card does not guarantee that you will be approved for one. Issuers are very cautious about extending credit, and the higher you are as a credit risk, the greater your chance is of being declined for the card. The lower your credit score is, the higher your interest rate will be if you are indeed approved for a credit card.
Once you are approved for a credit card, you will receive the card by mail. At this point, you will need to activate it by calling the number on your card from your home phone. This is done for security purposes to ensure that the correct party received the card and it was not delivered erroneously or stolen for fraudulent purposes.
As soon as your card is active you can begin to use it to make purchases or to receive cash advances. Be advised that cash advances tend to accrue interest from the moment of withdrawal and sometimes carry a higher interest rate, so you should read your agreement carefully. You can use your card online, on the phone, through the mail, or at a merchant’s point of sale (POS), which is typically a retail store but can also be a doctor’s office, livery service, or anywhere where credit cards are accepted.
Once you give your card to a retailer it will be swiped at a POS terminal that will read the account information off of the magnetic strip on the back of the card. If you give the number to someone over the phone or online, they will key the number into a virtual terminal. The issuing bank automatically approves or declines the card based on security and account status, allowing or disallowing you to use the card to make your purchase. The issuing bank pays the merchant within a few days of the transaction through a transaction network interchange, and you pay your credit card company on or before the assigned due date.
Responsible Use of a Credit Card
It is important to know what your credit limit is and to track your balance at all times. Your card can be declined if you go over your limit. Going over your limit can also affect your interest rate and you can accrue miscellaneous fees on your account. You can also be charged late fees if you do not make your monthly payment on time. Grace periods vary by credit card, but if you fail to make your payment on time, not only will you incur late fees, but you can trigger your default interest rate if you had a promotional rate in effect.
Furthermore, if you default on one card, you can trigger higher interest rates on all of your cards through a practice called Universal Default. By making your payments on time you can avoid these fees. And if you pay your balance in full every month, your interest charges are usually waived, giving you virtually free credit.
Every month you will receive a statement either by mail or online. In the interim you can obtain account activity and information online or by phoning your credit card company directly. In addition to using your statement to verify your charges, you can also use it to track expenses for budgeting purposes or to categorize business expenses.
If there is a charge on your account that you do not recognize, you must dispute it immediately. Dispute instructions can be obtained from the backside of your statement, from the issuer’s website, or by calling the phone number on your credit card. You are typically not responsible for any charges or accrued interest on disputed items.
Responsible use of a credit card can help you build a credit score, while the exact opposite is also true. Your use of credit cards have a major impact on your credit history, so understanding the way a credit card works and knowing the agreement you have with your particular issuer can help you avoid unnecessary fees, high interest rates, and negative credit reporting.
Secured Cards and Prepaid Cards
Secured credit cards work by issuing a credit card to a cardholder once he has made a deposit that is anywhere up to 200% of the credit card limit requested. The deposit can be used in case the cardholder seriously defaults on the loan or cancels the card with charges still pending. Typical users of secured credit cards are cardholders with no credit history or a poor credit history. If a regular credit card cannot be obtained, this is something to consider to not only give you the convenience of a credit card but to help you build your credit score as well, provided you use it responsibly and the issuer reports your account activity to the credit reporting agencies.
Prepaid cards are not credit cards at all and can mislead many people. Prepaid cards are simply cards that have been purchased with a limit set by the purchase amount. For example, for $100 you can purchase a prepaid card that will have a $100 starting balance on it. There are usually fees associated with prepaid cards and are more often used for gift giving or to eliminate the need to carry cash. Since there is no credit involved in a prepaid card, there is no effect of a prepaid card on your credit history.
Finding the Best Credit Cards
Credit cards are very simple to use but can have complex rules. The fine print should always be read and understood so that you can use the card to build your credit score, have worldwide payment convenience, and enjoy some perks that are offered by various reward programs. Compare various credit cards now to get the best offers by using the free credit card “Chaser” tool on this page. Get started finding the best credit card offers now!
