The basics of credit cards

Your guides jump into plastic!

CarlosWhen you shop or pay the bills, how do you pay for things? Cash? Debit card? Maybe sometimes you use a credit card.

OliviaIf you do, here’s the important thing to remember: if you repay what you borrow over time, you’ll be charged interest each month on the amount you still owe. So with a credit card, the total amount you end up spending on things may be quite a bit higher!

CarlosBut if you pay off your purchases by paying your first credit card statement in full within the grace period, you’ll pay no interest, plus you’ll have your full credit limit available to use again.

OliviaAnd take it from us, once you have a card it’s very easy to use it. But to use credit cards the smart way, you need to know the basics of what they are and how they work.

Credit card facts

Applying for a card
When you apply for a credit card, the financial institution will check your credit history and decide whether or not to give you a card. They’ll also decide how much you’re allowed to borrow, or “charge.” This is called your credit limit.

How credit cards work
Every time you use a credit card, you’re actually borrowing money from the financial institution that issued you the card. The financial institution pays the debt to the store for what you bought. You then pay the money back to the financial institution. (Remember: debit cards work differently! When you use a debit card at a store, you may have the option of selecting “debit” and entering your PIN, or “credit” and signing your name. Either way, the money is deducted from your checking account.)

Interest and interest rates
Interest is the amount of money paid by a borrower to a lender in exchange for the use of the lender’s money for certain period of time. (You earn interest from a bank if you have a savings account and you pay interest to a lender if you have a loan.) The interest rate is the amount of interest paid per year divided by the principal amount (the amount loaned). Example: if you paid $500 in interest per year for a loan of $10,000, the interest rate is 500 divided by 10,000, or five percent (5%).

Revolving credit
Credit cards are called revolving credit because as you pay the money back, your credit becomes available for you to use again and again. (A second type of credit is installment credit. If you have an installment loan, you borrow the money and just once and repay the lender in equal amounts, over a fixed period of time.)

Secured vs. unsecured cards
A secured credit card is a credit card backed by a savings account. The money in the savings account is collateral, which means it may be claimed by the company issuing the card if the account holder fails to make the necessary payments. Using a secured credit card and paying according to the terms of the agreement can be a good first step for individuals or businesses that want to establish or rebuild their credit.

Annual fee, finance charge, grace period
Some financial institutions charge an annual fee for their credit cards. This fee is the amount they charge a credit card holder to use the card for a year. The term finance charges means the amount of money a borrower pays to a lender for the privilege of borrowing money, including interest and other service charges. The grace period is the length of time, as defined in the cardmember agreement, between the use of credit to make a purchase and the start of interest on the amount charged.

Statements and e-mail alerts
Every month, your credit card company will send you a monthly accounting document that lists all of the charges and payments you have made, finance charges, the total amount you owe, and the minimum amount due. Every time you use your card, save your receipt. Every month, compare your receipts to your statement. Many credit card companies let you check your transactions and make payments online, and offer e-mail alerts to let you know when you’re close to your credit limit and payment due dates.

Note: Credit cards can be more convenient than carrying cash, but remember, you always have to pay the money back. Lots of financial institutions offer credit cards; shop around for a low interest rate.

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