Credit Card
Credit Card
A credit card is a payment card issued to individuals (and sometimes businesses) that allows the cardholder to borrow funds with which to pay for goods and services with merchants accepting cards. Unlike a Debit card, which draws funds directly from a checking account, a credit card involves a line of credit extended by an issuer, typically a Bank or Credit union. This borrowed money must be repaid, usually with interest, according to the terms and conditions agreed upon in the Credit agreement. Understanding credit cards is fundamental to managing Personal finance and building a good Credit history.
How Credit Cards Work
The basic process involves several parties: the cardholder (you), the issuer (the bank), the merchant, and the Payment network (like Visa, Mastercard, American Express, or Discover).
1. You use your credit card to make a purchase. 2. The merchant submits the transaction to their Acquiring bank. 3. The acquiring bank forwards the transaction to the payment network. 4. The payment network routes the transaction to your card issuer. 5. Your issuer approves or denies the transaction based on your available credit and other factors. 6. If approved, the issuer pays the merchant, and you receive a Statement detailing your purchases. 7. You are then responsible for repaying the amount you borrowed, either in full or over time.
Key Terms
- Credit Limit: The maximum amount you can borrow on the card.
- APR (Annual Percentage Rate): The annual interest rate charged on outstanding balances. This is a critical factor in determining the cost of borrowing. Understanding Interest rate calculations is crucial.
- Grace Period: The period between the end of a billing cycle and the payment due date, during which no interest is charged if you pay your balance in full.
- Minimum Payment: The smallest amount you must pay each month to avoid late fees and damage to your Credit score.
- Credit Utilization Ratio: The amount of credit you're using divided by your total credit limit. Keeping this ratio low (ideally below 30%) is important for maintaining a good credit score. Relates to Risk management in lending.
- Cash Advance: Withdrawing cash from your credit card. Typically has higher fees and interest rates than purchases.
- Balance Transfer: Moving debt from one credit card to another, often to take advantage of a lower Interest rate.
Types of Credit Cards
There are numerous types of credit cards, each designed for different needs:
- Rewards Cards: Offer rewards like Cash back, points, or miles for purchases.
- Travel Cards: Specifically designed for travelers, often with benefits like travel insurance and airport lounge access.
- Low-Interest Cards: Offer a lower APR, ideal for those who carry a balance.
- Balance Transfer Cards: Designed for transferring debt from other cards.
- Secured Cards: Require a security deposit, making them accessible to those with limited or poor credit history. These are helpful for building Creditworthiness.
- Student Cards: Designed for students with limited credit history.
- Business Cards: Designed for business expenses, often with rewards tailored to business spending.
Benefits of Using Credit Cards
- Building Credit: Responsible credit card use is a key factor in building a positive Credit report.
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