When used properly, credit cards are a flexible and secure way to make payments. They can also be an effective way to facilitate major purchases by spreading the costs. However, if you run up bills that you are unable to pay or stick to making minimum payments, a credit card can end up being a costly choice. It is important to be aware of how credit cards actually work in order to determine whether or not they are the right choice for you.
Understanding credit cards
Credit cards enable you to use money on credit basis. This is comparable to a loan for how much you spend while using the card. A credit limit is set for the maximum amount you can spend, which varies widely and depends on the card issuer’s confidence in your ability to pay back.
You will not be required to pay interest on the amount that is borrowed if the bill is paid off in full every month. Interest is typically charged every day when cash withdrawals are made. This is why it is advisable to avoid using a credit card to withdraw cash. There are charges for this purpose and cash withdrawal interest rates are typically higher than the charges for purchases.
Interest will also be charged if you do not pay off outstanding balances. It is typically backdated as well, which means that if you buy something at the beginning of the month, a whole month worth of interest will be charged.
Considering a credit card
Credit cards provide a fast way to build credit, protect consumers and they also offer convenience when they are used responsibly. Using them recklessly means that your credit will be compromised, which has an adverse effect on the ability you have to borrow money later.
A credit card is basically a plastic card that enables you to access a line of credit that is provided by the credit card issuer. Each time you pay with a credit card, you borrow money from the issuer to cater for the cost of the purchase. You are required to pay the money back in full over time or at the end of the month.
Functionality
When your application for a credit card is approved, the issuer sets a card limit. This limit refers to the maximum amount that you are allowed to borrow and you are at liberty to use this amount at your discretion. Credit limits are influenced by factors such as the credit you have on different cards, other debts and income.
- Credit card transactions are processed by various networks such as MasterCard and Visa. They ensure that the money used to make the purchase reaches the merchant and the right cardholder gets the bill.
- When you get your bill, you can choose to pay a specified minimum amount, pay the entire balance in full or pay something between the minimum and full amount. The costliest option is paying the minimum each month because your card ends up accruing a lot of interest. The best option is to pay in full every month because the grace period enables you to avoid interest on the purchases you make.
- Credit card issuers usually report the payments to credit bureaus that are responsible for preparing credit reports. A person’s history of payments accounts for a significant percentage of their credit score. Credit scores show how risky is to lend someone money. You should strive to at least pay the minimum by the due date every month to avoid late fees and the risk of damaging your credit score.
Pros and cons of credit cards
Pros
As long as credit cards are used properly, they can have numerous advantages as alternatives to cash payments and debit cards.
1. Spreading out purchases
When you have a credit card, you can spread out large purchases over multiple monthly payments. With this solution, it can be used for emergencies when you may find it difficult to pay immediately for an item you need. Credit cards make it possible for consumers to make large purchases that they would not have been able to afford under other circumstances.
2. Rewards and benefits
Several credit cards feature various incentives and benefits that can be useful when you choose the right cards. Cards often provide reward programs that accrue benefits such as frequent flyer miles, redeemable points and discounts.
3. Convenience
With a credit card, the need for cash is minimized. Many retailers accept a credit card as payment and they are usually necessary for online purchases. It can also be convenient to use a credit card that allows you to pay for a service or product and pay for it through monthly repayments when payday arrives.
4. Tracking
Credit cards come with records that are electronically or digitally kept, which makes it much easier to track spending and fraud. If your card is stolen or lost, all you have to do is contact the bank and cancel the card. You will also be more likely to get your money back if the card is used fraudulently or stolen.
5. Emergencies
A credit card can be an effective solution in emergency situations. If you encounter an unexpected expense, using a credit card can be a simple and fast way out. Although it is advisable to avoid spending money that you do not have or that is not within your budget, emergencies such as a fire, flood or vehicle breakdown can lead to unforeseen expenses such as having to pay for a hotel room or rental car.
6. Credit history
Using a credit card responsibly builds one’s credit history over time. This qualifies you for various financial benefits such as better interest rates.
Cons
Consider the following disadvantages when using a credit card:
1. Excessive spending
While credit cards certainly make life easier, they can also make it easy to overspend. Using a credit card means that you are spending money you may not have yet and if you are not cautious, this can result in mounting debt over time.
2. Charges
Credit basically means you are borrowing money and borrowing comes with costs. Poor management of a credit card could make you end up deep in debt due to fees and interest charges as well as a maxed-out card or high balance.
3. Additional fees
Along with interest, you may pay penalties or additional fees when you miss a payment or exceed your credit limit. Fees are also charged for cash machines and there may be monthly or annual fees.
4. Fraudulent activity
Electronic payment methods such as credit cards are associated with certain risks. A credit card can be stolen and used for the purpose of stealing your identity and money.
5. Debt
Carrying a balance on a credit card each month makes it easy to rack up interest and charges. Some people do not think that a credit card can lead to more debt but in reality, this can easily happen if you are not careful.
6. Limitations
You may be limited in regard to where and how you can use your credit card. Many issuers charge for using the card overseas or withdrawing cash, depending on the details of the credit card agreement.
Conclusion
Credit cards are great tools that make life easier, but they can lead to financial trouble if they are not used wisely. If you make the choice to use credit cards, there are a number of considerations that you should keep in mind. These include monitoring your purchases, spending within your budget, paying off your credit card balances at the end of every month and keeping your credit card information confidential at all times.
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