How do credit cards work?
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Here is the basic way in which a credit card works:
- The customer applies for their chosen credit card.
- The credit card provider assesses their application and accepts or rejects it based on credit history, and personal and financial details.
- If accepted, the credit card company sets a credit limit on the customer’s account, according to their credit history and current income and expenditure.
- The customer is allowed a certain amount of interest-free days. Interest-free days mean that any purchases made in a month where the balance was at zero at the start of the month will not be charged any interest.
- The applicant receives their credit card and confirms receipt of it, opening the account for business.
- The card holder proffers their piece of plastic in exchange for goods or services from a retailer or company, either on the high street, over the phone or via the internet.
- The credit card company picks up the tab for a certain number of days before the bill is presented to the customer in the form of their monthly statement.
- At that point, the customer is given the option of repaying all or part of the bill, but they are always required to pay back a minimum amount, which is usually around 2% to 3% of the balance amount.
- If they choose the latter part-payment option, the credit card provider starts applying interest to their remaining balance at a predetermined rate, which can be anything from 11% to 20%. (Although the interest rate and the APR – annual percentage rate – are not strictly the same thing, it is not worth discussing this in detail in an overview article.)
- As the months go by, purchases may be added to the balance, but there will be no interest-free days on new purchases whilst a balance exists from the previous month.
- Until the debt is cleared in full, interest continues to be added to the entire amount of the balance.
There are numerous other issues to consider when looking at how a credit card works, such as balance transfer offers, cash transactions, the order of payments, and rewards schemes, but the basic premise is listed in these numbered points.
A credit card can be an extremely useful tool to carry with you, and should ideally exist as a simple short-term loan arrangement between the customer and the credit card provider. This is when a credit card works best. As long as you are spending within your means and clearing your debt every month, you should experience no problems whatsoever with your credit card.
This article was written by Jeremy Cabral who is a regular writer and part of the team at Credit Card Finder, a 100% free Australian credit card comparison and application service. Visit the Credit Card Finder website for more information on the available Australian credit cards, or subscribe to their RSS feed for more practical articles.