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October 6, 2007 | Filed in: Finance 101, Loans and Credit, Personal Finance | No comment
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I post at a few different message boards on my free time and a poster on the boards started a topic with a few questions about credit cards. He wanted to know some basic information about them, such as the sort of features you should look for in a credit card, if they come with liability protection, things of that sort. Having worked in the banking industry for a few years and also having been interested in finance and how the different markets work since I was around seventeen years old I thought I might try and tackle his questions. That’s what I’d like to talk about today.
Credit Card Basics
A credit card gives you access to a revolving line of credit - the limit of which is set by your creditor (the company issuing the card) - which you can use to purchase services and products just about anywhere. There are four major credit card companies in the United States: Visa; MasterCard; Discover and American Express. When you use a credit card the purchase amount is debited (this is an accounting term which in this example means ‘added to your balance’) from your line of credit and credited (e.g. paid) to the vendor from whom you made a purchase. Within a month of your purchase (credit card bills are generally sent out on a monthly basis) you will receive a bill from your credit card company showing any purchases throughout the previous month, the full balance owed, and a minimum payment amount. It is important to remember that the minimum payment amount is a ludicrously low percentage of the full balance owed and with a purchase of even a few hundred dollars it could take years to pay off a credit card when only paying the minimum amount.
So why are credit cards important? Wouldn’t it be better to just pay with cash? Short answer is: not always. Credit cards can be a convenience but I make it a habit to not think of them as one, but rather more as a tool… and a dangerous one at that, if not used properly and with strong self-control. To understand why credit cards are important, one must first learn how consumer lending (in all its flavors: auto loans, mortgages, etc.) works. To keep things simple I’ll bring up only one part of consumer lending qualification: the credit report and more specifically the credit score. Credit scores are reflections of your ability to borrow and to repay money. So when you purchase something with your credit card and then pay off the balance on time this is reported to credit scoring agencies, who then update your credit report and score on a monthly basis. The higher your credit score the easier it will be for you to qualify for loans of all types.
Choosing a Credit Card
When looking for a credit card you want to read the fine print. The Terms and Conditions of the card you are considering must legally be provided BEFORE a card can be applied for. These are the things you should pay close attention to:
- Annual Percentage Rate
- Annual Fees
- Balance Transfer Fees
- Cash Advance Fees
- Late Payment and Overlimit Fees
- Minimum Finance Charges
You should look for a card with a low APR, no annual fees, a low balance transfer fee, and NO minimum finance charges (these are ridiculous and I won’t keep a card that charges a minimum finance charge).
Fraud Protection
VISA cards offer a zero liability policy, which with a few exceptions basically protects you from all forms of credit card theft and fraud. If someone were to get a hold of your card number somehow and make a purchase with it all that needs to be done is to report it to VISA and you will not be held responsible under most circumstances. More information can be found at Visa’s website. MasterCard, American Express and Discover Card likewise offer fraud protection. This is another reason why I prefer credit cards over cash; the security is far superior.
That’s about all I’ve got for now. If you have any questions about credit cards feel free to post a comment or send me an e-mail. A good place to compare credit cards is at Bankrate.com
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