How Credit Cards work – A Detailed Guide

A credit card is a slim, electronic rectangular plastic card issued by the financial institution that enables an individual or cardholders to borrow funds with which the cardholder can pay for goods and services.

In this blog post, we will explain in detail how the Credit Cards work

While the card issuer allows the customer to purchase things instantly online, or from a store, that’s not the end of the story.  It is based on the cardholder’s promise to the card issuer to repay the borrowed amount along with the interest amount and some predetermined fees. 

The amount that an individual owes for the unpaid purchases is known as the credit card balance. The financial institution may also grant a LOC (Line of Credit) to the cardholder.

A Line of Credit is a predetermined arrangement between the credit card company and the cardholder that determines the maximum amount of loan a customer can apply for. LOC enables customers to borrow funds in the form of cash advances and the borrowed funds can be accessed as long as they don’t exceed the credit limit set in the agreement and meet other requirements such as making timely minimum payments.

Now, the credit card is one of the most popular payment methodologies for buying consumer goods and services. Since all credit card activities are reported to the credit bureaus, having a good credit history by using your card responsibly will help you have a good credit score. Having a good credit score will enable you to get big figure loans like a mortgage, or when you are applying for an apartment in the near future.

But first of all you must understand how Credit Works so keep reading the blog post and let us know any issues in the comments.

How do Credit Cards work

Credit cards are a very essential and fundamental tool from the financial point of view. This card uses the issuer’s money at first and bills it to the customer later on.

Also, one is given credit card points based on the usage of the particular card. This point history is checked while taking some bigger loan whether it is for mortgage purpose or job application. One has to maintain a certain number of points to be eligible for big transactions like buying an apartment or a vehicle.

One will come across various terms while using credit cards regularly and getting a brush off knowledge about the credit card terms is necessary

  • There’s a credit limit which needs to be maintained which depends on the amount of the current loan. The issuer decides the amount. More the credit along with your income, higher is your credit limit.
  • Balance is the amount you are supposed to pay back or haven’t paid back after spending it on purchases.
  • Available credit is the amount of money you can spend before reaching the credit limit of the card.

Credit Card terminology

Do you want to improve your financial well-being? Want to make the best of your credit card and maintain a healthy credit? Take the first step in increasing your credit vocabulary by getting familiar with the credit card terminologies which helps in processing the card:

  • Credit Limit: The value of your credit limit signifies the maximum amount of money you can spend at a time. In other words, it is simply the size of your ongoing loan.  The credit limit is decided by the financial institution. It depends on a variety of factors. The credit limit will be higher if you earn more, and have a good credit history.  It is possible to increase your credit limit by following some tips:
    • Automatic credit card limit increases: Credit card companies increase your credit limit automatically while you sit back. All you have to do is prove that you are a responsible card user by using the card enough to qualify for a higher credit limit, the credit card company increases your credit limit as frequently as every 6 to 12 months. So you should start by building a positive credit history by avoiding late payments or returned payments, swiping your credit card frequently to generate enough swipe fee.
    • Request for a Credit limit increment: Automatic credit limit takes time to grow. If you do not want to wait, you can request for a credit limit increment by filling out online forms provided by the credit card or by contacting the customer service. However, you should keep in mind that requests for credit limit increment will result in detailed inspection on your credit reports which can slightly lower your credit score. 
  • Balance: Credit Balance is the amount of money that has already been spent on your card and have not been paid back to the card issuer. This Balance amount is also called Credit Debt. Suppose you have purchased an item worth $200 and have not paid it yet, then your Credit debt or Credit Balance is $200.
  • Available Credit: This is the amount of money that you are allowed to spend before you hit the credit limit  The moment you exceed your available credit, you owe credit balance or credit debt to the credit card company. Suppose Your credit limit is $1500 and have a balance of $300, then your available Credit is $1200. Now if you make a payment of $100 then it will go back to $1300.
  • Billing Cycle: Billing Cycle is the span of time within which the cardholder is allowed to make purchases using the credit card. After the time span is over, you will receive a bill that you have to pay within one month.
  • Statement Due Date: The last day of your billing cycle is called Statement Due Date. It is the date on your credit card statement by which the cardholder must pay at least the minimum payment set according to the bank to keep your credit card account up and running.
  • Minimum Payment: Minimum Payment is the lowest amount of monthly payment that has to be made to the bank. It is usually a small fraction of your total balance. If the Minimum Payment is not made by the due date, the financial institution is entitled to charge an amount of late fee from you. If you make late payments, the credit card company will send a report of “Late Payment” to the Credit Bureau which will stay in your credit card statement for at least 7 years.
  • Annual Percentage Rate(APR): Annual Percentage Rate is the interest rate is that applied to the remaining debt when you don’t pay the full statement balance. So, when you are not able to pay the Credit card balance in full, you have to repay the remaining balance along with some extra money which has been determined by the APR.

What is Credit Card fees

While opening the account, all credit cards cost certain fees, APR and fees are mentioned in the agreement paper that you sign at the beginning where all the rules and procedures are mentioned. Credit cards have their own fee schedules, some charge more or less.

The annual fee is a must one that you have to pay at the end of a year. The fee depends on the type of card that you have.

Some other types of fees are mentioned below:

  • Cash advance fees: When you borrow money in advance in cash or line of credit without making any actual purchase.
  • Balance transfer fees: When you use your card to pay the balance of some other card, like literally referring to transfer of your balance amount from one card to another.
  • Late payment fees: If the credit card payment is done after the date is due, then this is known as the late payment fee.
  • Foreign transaction fees: For purchases in foreign countries, this type of fee is charged.

Types of Credit Cards

​There are many types of credit cards each having a different function and benefits :

  • Rewards credit card: The concept of a Rewards Credit Card depends on the purchase made on the credit card. With every eligible purchase made on the Rewards Credit Card, the cardholder will be rewarded in terms of Cashback, or in terms of Reward Points, which can be redeemed for travel expenses or other purchases. 
  • Secure credit card: It is true that handling credit cards can become expensive if it is not used responsibly. Thus, for people who want to avoid having credit debt and want to build their credit, Secured credit card is a good option. It requires a cash deposit which will serve as a collateral when you can’t pay the statement balance in full and thereby saving you from credit card debt.
  • Charge cards: They are almost like the traditional cards but don’t have a credit limit but you will have a limit on your spending limit.

Check out all the Different Credit Cards here

Credit Card Interest Cost

Credit card interest is the amount of money you have to pay for having a balance. The money that you have to pay, is variable. That is, the amount is not constant as it is set by the credit card Annual Percentage Rate.

APR is the interest rate charged when you are unable to pay the monthly statement balance in full.

This is one of the primary reasons why people are afraid to open a credit card account. With a market average of 14% APR, the total amount that the cardholder has to pay becomes huge and thus your balance goes out of control thereby opening the gates of Credit Debt for you.

However, APR can be completely avoided if you can somehow pay the statement balance in full every month. In that way, you won’t be charged a dime in interest. The key rule to maintain a good credit score and staying out of credit debt is to use the credit card you have, responsibly.

Grace Periods are a blessing for credit card users. The grace period is the time that the bank provides to pay your monthly statement balance. After the Grace Period is over, a variable APR becomes applicable on your credit balance. The average Grace Period varies from 25-30 days.

Final Words

So now you know how does Credit cards work and now you can easily get the credit card and use it wisely for your own benefit.

If you face any issue then you can comment down below and our team will get back to you.