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How Credit Cards Work

How Credit Cards Work

There are many credit card companies trying to give you credit. Before you take that new T-shirt or water bottle, you should be aware of a few important facts.

You get credit by promising to pay in the future for something you receive in the present. It is the consumer's ability to assure the lender that the money will be repaid.

Credit is a convenience. It lets you charge a meal on your credit card, pay for an appliance on the installment plan, take out a loan to buy a house, or pay for schooling or vacations. With credit, you can enjoy your purchase while you are paying for it or you can make a purchase when you are lacking ready cash.

But there also are strings attached to credit. It is essential that one know the dangers of credit abuse. What is borrowed must be paid back.

If you are thinking of borrowing or opening a credit account, your first step should be to figure out how much it will cost you and whether you can afford it.

All creditors, whether it is a bank, credit card company, retail store, or car dealer, must state the cost of their credit in terms of the finance charge and the Annual Percentage Rate (APR).

  • The finance charge is the total dollar amount you pay to use credit. It includes interest costs, and sometimes other costs, such as service charges.
  • The annual percentage rate (APR) is the percentage cost or relative cost of credit on a yearly basis.

Each issuing bank or lending institution sets its own interest rates and fees for credit cards. Shop around for the best deal. Do not take the first card that offers you a free gift. That free gift could cost you a lot of money, in higher interest rates and fees.

Be aware of your grace period. Most grace periods offer you the ability to pay your balance interest free. A grace period is only available if you pay your bill in full and if you are not carrying any balance from the previous month. A grace period does not apply if there is an outstanding debt.

Grace periods never apply to cash advances. Interest on cash advance starts to accrue from the very first day. Plus, some institutions charge an extra 2 percent or more for a cash advance. This is in addition to the regular interest rate.

Pay as much as you can. Lenders always ask for the lowest possible payment. By paying just the minimum payment due each month, you will run up your interest charges and remain in debt.

When can too many credit cards hurt you? If you have too many credit cards, it can prevent you from getting other loans. Even with all your accounts up to date and or at a zero balance, some creditors may deny you from receiving new credit.

Potential lenders will look at your credit report. When they see how much potential credit you have, creditors may assume you would be unable to pay back your debt if you used your credit cards.

What's wrong with taking the credit card offers that are mailed to me? You may be offered a bank card through a college, a charity, or other organizations. Before applying for the card, find out if they bargained for a great deal for their members or themselves. Some organizations receive 0.5 percent of whatever you charge on the card or a payment for everyone who signs up. This may make the card more expensive for you.

A credit card only make sense if the interest rate is competitive, it has a grace period and no annual fee. If you feel you want to support your college, charity, or any other non-profit organization, donate money. At least the donation is tax deductible.

Temple University offers this consumer information as a service and does not recommend any particular credit card companies or lenders to students.