How Credit Cards Work

Credit Cards: Beginners Guide

Are you a beginner to the world of Credit Cards? Do you know how Credit Cards work? Then the analogy of the Mafia Fairy by Avery Alder, Buried Without Ceremony should be your first read on Credit Card 101. Simply put, a Credit Card is essentially a type of short-term loan which may or may not be linked directly to your checking or money market accounts. It does carry balances that accrue interest and charges which are sent in a monthly bill.

Mastering the science of racking up bonus miles and cashback rewards (something you will probably never achieve) is totally rewarding, and can help you easily build strong credit history (a plus in showing future lenders you can manage debts). Moreover, a lack of knowledge and a ‘just once’ mentality will cost you a fortune and probably land you in cyclical debts (card debt).

Credit Cards may eliminate the need for hard cash doing bookings and make online purchases a breeze as some cards come with protection against fraud hence you are not responsible for unauthorized purchases on your card (Fraud liability Guarantee)

How do Credit Cards work

A contract is signed by the borrower (You) and the issuer (Bank) to lend you some money known as a credit to spend in the Credit Card networks that accept card payments. Any amount left on the card after spending is known as available credit or line of credit. Credit spent is paid at the end of the billing cycle, usually, a month and more credit will be available to spend again. Any amounts left unpaid at the end of the cycle are known as balance (revolving credit) and this attracts interest and penalties after a grace period (read terms and conditions to verify grace period).

Advantages of Credit Cards

 Credit Card Credit Score

If you are looking forward to accessing credit in the future let’s say to get a good mortgage, the credit score is very key. You can easily build credit by using your credit card responsibly. Even a person with no credit history can start with a secured card and build up progressively.

Credit Card Grace Period

With a credit card, the issuer pays and the cardholder has a maximum of 60 days to clear the payment freeing up some personal cash.

Credit Card Security and Consumer Protection

It makes it easy to resolve billing issues with merchants when returning a defective product. Also, Most Cards have built-in guarantees against unauthorized usage.

Credit Card Reward Points

Certain purchases can earn Cashback and travel Points redeemable for cash, travel, or gift points. Depending on your spending habits, you might be able to finance entire vacations with reward points! But watch out, they are usually pegged to a certain spending bracket especially on cards with annual fees.

4 Factors to Consider When Choosing Your First Card

Credit Card APR (Credit card Interest)

Here’s a simple example- If your credit card has an APR of 20% and you make purchases worth $1,000, this would be the balance at the billing cycle. If you pay off $1,000 in full on the due date you won’t incur any charges. You also have the option of making minimum payments to keep your account in good standing (usually 3% of the balance plus interest).

Things get interesting if you choose the minimum payments route, technically the balance may grow to $1,200 at the end of one year and it might keep on piling. It’s a clear sign you are spending more than you can afford, you are affording a lifestyle with the most expensive loan available! In short, you need only borrow what you can repay at the end of the billing period.

Credit Card Credit Limit

This is the absolute maximum that you can spend on the card. Without a doubt, having a high limit indicates a high credit score but also increases the chances of falling into the pitfall and raking up unmanageable debts.

Issuers will tie the limit to your credit scores i.e. your payment history (ability to pay) and credit utilization in the past (Amount available to borrow vs. amount borrowed). Most lenders consider a credit utilization of 30% as responsible borrowing –if your collective limit is $1,000, you should never spend more than $300 at any particular time. You can always increase your credit utilization rate by requesting a higher credit limit. Go for a card that offers a free FICO® Score tracker to keep track of your scores on the move.

Credit Card Sign up offers

Some cards can offer as much as a $200 bonus on the first $500 purchase in your first 3 months from account opening! Some issuers may throw in a 5% cash on purchases on merchant networks up to $12,000 within the first year!

Please remember that it’s good practice to clear any balances at the end of the billing cycle, and as much as these offers are enticing, it might be the highway to raking unmanageable debts and earning a bad credit utilization ratio!

Credit Card Annual Fees

Considering this is your first card, and it’s something you will hold a long time to help you build a good credit score, ideally you should go for a card that charges no annual fees. Nearly 70% of cards don’t charge this fee.

But in real life setting credit card fees are unavoidable, considering the benefits and unlocked doors that come with the fees, a better understanding of the fees may actually save you some cash.

Recent surveys put the fee at an average of $110. Is it worth it? Yes-key is to match spending habits with rewards schemes within the card!

Requirements to Get a Credit Card

Credit Card Accountability Responsibility and Disclosure Act (CARD Act) of 2009 requires that you are at least 21 years of age. You can Co-sign with the parent and show solid proof of independent income if under 18 years of age. Under CARD, Issuers need to request proof of ability to make minimum payments (Source of income).

As part of KYC. U.S. lenders may inquire whether you are a U.S. Citizen or allowed to work in the Country by providing a valid mailing address.

How to Apply for A Credit Card

You can apply over the internet. You can also walk into the Issuers bank office and apply or you can apply via a telephone call.

When making the application, typical requirements will be as follows;

• Legal Name
• Social Security or ITIIN Number
• Valid U.S. Address
• Proof of Income
• Housing Costs/Expenses- to determine the extent of Credit.

Credit card Preapproval and Approval

This simply means you have been prequalified and there is some action required on your part. This should be taken as a guarantee of success rather than the likelihood of success.

If you are approved, you will be informed of the credit limit, the APR, and the billing date. Also, you will be provided with the terms and conditions of the card. Lastly, You need to read and understand the card’s terms and conditions in the Schumers box.

All is not lost if a credit card application is denied

The issuer will decline in writing (Adverse Action Letter). You have a right to talk to the credit bureau if the information provided to the issuer is wrong. Major reasons for denial usually are;

• Low credit score
• Low income
• Accounts in collection
• Too many credit cards

The application can be denied due to a low credit score. Don’t reapply immediately, do it in six months’ time and ensure you;

• Clear off any outstanding or defaulted debts
• Decrease your credit utilization ratio
• Participate as an authorizer in a family member’s linked account to build history
• You can get a Co-signer who already has good credit through a local bank
• Get a secured card to build credit and apply for unsecured credit.

Dos and Don’ts of Credit Cards

This is the best way to use credit cards responsibly;

• Do not overspend: Don’t go crazy over a huge credit limit, this is not free money! Only purchase what you can afford, and pay off fully at the end of the billing cycle.
• Do not go above your credit limit: Aim for a 30% credit utilization limit. Anything above points to financial indiscipline and will bring your credit score down.
• Avoid Minimum payments: Settle your balance in full at the end of the billing cycle, as any amount you carry will start accruing interest, which will accrue until the day you figure a way to clear the balance.
• Limit cash advances: The issuer will charge cash advance fees, ATM Bank fees, and higher interest than normal credit cash purchases.
• Do Find rewards worth your attention: Do not spend to access rewards, rather align your spending with rewards. Make sure the rewards are accessible and not a marketing gimmick.
• Do get a card with Built-in Protection: Go for a card that has purchase protection and protection against unauthorized usage of cards.
• Review your statements: Look for any anomalies and point them out to the issuer