Credit Cards Explained
Credit is the exchange of goods or services in return for a promise of future repayment. The word comes from the Latin "Credere" which means "to believe" and the history of credit has its roots in the ancient world as far back as 1300 BC.
The lender has to believe that the borrower will repay the money back, therefore the borrower has to be credible, or believable. So, in modern parlance when somebody says "give me credit" it is really another way of saying "believe in me".
The Advantages of Credit
Access to credit can facilitate a wide variety of financial transactions. Borrowers don't want to be restricted to purchases that only match the value of the funds in their bank accounts while vendors want to be able to trade in high value goods and services.
For it to all come together, the creditor or lender has to have a motive for making the funds available, as they could easily be invested more securely than lending to an individual.
An interest fee is therefore applied to the sum being borrowed. So, in theory, the lender ultimately receives back more than they paid out as compensation for their risk and for temporarily relinquishing the funds.
What are Credit Cards?
Though a credit arrangement can take on many forms, over the past 50 years credit cards have become an increasingly popular option. In terms of practical usage, credit cards work in a very similar way to the debit card attached to your bank account, so there is flexibility to make transactions as and when required with the only restriction being the agreed credit limit on the card.
A credit card starts with you owing zero and climbs up indefinitely according to the purchases you make on it. This total will usually also include interest charges as well as other fees agreed between the borrower and lender.
It is in the clear interest of the lender when the borrower only pays the minimum amount required per month because this way, particularly if there is a large balance on the card, the borrower will accrue higher and higher interest. Although this only applies if the borrower defaults on the debt, otherwise it does not.
The Different Credit Card Options
It's no secret that there are many different types of credit cards available today – enough, certainly, to leave the average person spoilt for choice. It is important to keep in mind though that different credit cards suit different people. Before settling on your ideal credit card, you should first consider factors such as spending patterns and credit history.
When you pay for something on a credit card you are essentially taking out an on-the-spot loan that you will eventually need to pay back.
As nearly all credit card providers offer interest free terms for up to 59 days though, you can effectively borrow money for free provided of course you are able to repay the balance in full before this time period expires. If you are unable to pay the balance in full by this time, you will be subject to significant interest charges.
As explained however, credit card providers want you to spend more than you can afford to repay in a single monthly repayment, allowing them to charge you interest, typically around 19% APR (Annual Percentage Rate).
This is why your own spending and repayment patterns are important to weigh-up before considering different types of credit card. If you're never late in paying off your total balance then interest rates are unimportant. Instead, pick a card that offers bonuses based on how much you spend. Cashback credit cards fit this profile perfectly.
Credit Cards That Give Back
If you plan to make a particularly sizeable one-off purchase in the near future - the latest flat screen TV or a new fridge for example - then a credit card that offers 0% interest on purchases is worthy of serious consideration.
Used in the right way, this type of card could prove very helpful as it will allow you to pay for your purchases in instalments without the burden of rising interest. Plan carefully though and don't overspend as ill-discipline will prove costly further down the line.
What if I Want to Change My Credit Card?
Existing credit card holders can benefit by taking out a 0% balance transfer credit card. These types of cards allow you to transfer the entire balance of your existing credit card over to them, and as such, they represent a great money-saving option, particularly if you have built up a significant debt on another card at a high interest rate.
When taking up the 0% balance transfer offer on a new card you will need to pay a fee but this is almost always worth it as it will save you a lot more money in the long term.
Are There Additional Perks Associated With Credit Cards?
There are many people who like the idea of air mile credit cards. As with cashback credit cards, these types of cards are most suited to you if you're able to fall into a regular pattern of paying off all or most of your balance each month.
This type of behaviour will allow you to accumulate air miles a lot faster than if you overspend and then get stuck paying off the minimum repayment figure each month.
What Can You Achieve By Managing Your Credit Card Responsibly?
Managing a credit card effectively also has the benefit of building up a strong credit history which strengthens that crucial belief lenders have to have in you before lending you money on acceptable terms.
It's important to know about your credit status because if you have a poor credit history and a therefore a low credit score, then you might get declined for credit, further reducing your credit score.
If you do have a poor credit score then you can apply for a type of credit card known as a credit builder card. These cards typically charge a higher interest rate but are designed to allow you to rebuild your credit score and demonstrate financial prudence.
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