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Credit Card Basics
Understanding the credit card basics can help you manage your overall finances and help you improve your credit score. By knowing the basics about credit card loans, fees, annual percentage rates etc...you can also find the best credit card offers.
Credit cards are so common and they are so easy to get, than many people do not stop to consider the basics of credit cards. However, it is important to understand the basic workings behind credit cards, and to understand how they work.
Credit cards are loans
The most important thing to realize about credit cards is that they are actually loans. Many people do not understand this fundamental fact about credit cards. The money that you charge is not actually yours. The card issuer (usually a bank) is actually lending you money. An interest rate is charged, and you have to pay the money back – usually in small installments.
Every time you use your credit card, the transaction is recorded and the amount deducted from your available line of credit. Your charges are added up, and interest fees must be paid. If you pay off your balance immediately, you won't have charges that are very high. If, however, you carry a balance, the interest will be added to your balance and you will have to pay even more back than you borrowed initially.
Annual percentage rate
The amount of interest you are charged is determined by the annual percentage rate (APR) on your credit card account. Interest is expressed on an annual basis, and it changes usually when other rates do. One of the most common ways for credit card companies to figure your APR is to use the prime rate as a base. The prime rate is the Fed funds rate plus 3 points. So, if the Fed rate is 1%, the prime rate is 4%. Some cards charge as little as prime plus 5 and others charge as much as prime plus 20, depending on your credit history and your history with the company.
If you have a card that charges prime plus 8 for our example, you would pay 12% APR. This may charged monthly, so every month you would pay 1% on your balance at the end of the month. If you had $1,000 at the end of the month, your interest would be $10. Some cards, however, charge according to an average daily balance. This means that even if your balance is 0 at the end of the month, you could still have interest charges. Average daily balance adds up all the balances (purchases minus credits) at the end of each day and averages them out, and charges interest on that.
Two cycle billing is something to be wary of. This type of billing takes transactions from the previous two months. This means that if you have $400 for one month, and pay it off, and make no purchases, and maintain a 0 balance for the second month, you would still pay interest on the $400 for another month. Try to avoid credit cards that figure using two cycle billing.
Also, it is important to realize that a credit card company can switch you to an extremely high default rate (29% - 34%) if you miss payments or are late with payments. Some companies will charge you a higher rate if you go over your limit as well.
Most credit cards offer a grace period. This is a period of time in which you avoid finance charges if you pay your balance in full. Not every credit card offers a free period, however. Some will charge you interest immediately. Others give you 14 – 20 days as a free period. If your card does offer a grace period, though, your monthly statement and bill must be mailed at least 14 days in advance so that you have time to take advantage of the period.
Credit card fees
All credit cards have fees that they charge users. The most avoidable fee is the annual fee. While some credit cards charge between $25 and $100 a month (depending on the type of card and its options), there are plenty of cards that do not charge annual fees. Because it is possible to find cards that do not charge annual fees, it is a good idea to avoid cards that do charge them. Some credit card issuers will waive your annual fee if you ask, or if you agree to spend a certain amount each year.
Other fees that credit card companies charge include:
It is important to be aware of the fees that you could be charged, and to avoid what fees you can.
Related Article: Understanding Your Credit >>
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