Credit Card basics

If used responsibly, credit cards offer convenience, consumer protection, and a quick way to build credit. Your credit may suffer if you use them irresponsibly, affecting your ability to borrow money in the future. Understanding how credit cards function will allow you to select the best cards, manage them effectively, and save money.

Credit Card Essentials

WHAT IS A CREDIT CARD?

A credit card is a plastic or metal card that grants access to a line of credit offered by the issuing bank. Every time you use a credit card to make a purchase, you borrow money from the card issuer to cover the cost. You must then repay the money, either in full at the end of the month or in instalments.

HOW DO CREDIT CARDS WORK?

When you are granted a credit card, the bank authorises a credit limit, which is the maximum amount you can borrow. Your credit limit will be determined by factors such as your income, other debts, and available credit on other cards.

Visa, Mastercard, Discover, and American Express are payment networks that process credit card transactions. They ensure that the merchant receives payment for the transaction and that the correct cardholder is billed.

When your bill arrives, you have the option of paying a specified minimum amount, the entire balance in full, or a sum in between. Monthly minimum payments are ultimately the most expensive option because they incur the most interest charges. The best option is to pay in full; when you pay in full each month, you receive a grace period that allows you to avoid paying interest on any purchases.

Your credit card issuer notifies the credit bureaus, the organizations that compile credit reports, of your payment history. Your payment history comprises 35% of your credit score, which is a three-digit number indicating the risk associated with lending you money. Monthly minimum payments must be made by the due date to avoid late fees and potential credit score damage.

HOW DIFFERENT ARE CREDIT CARDS FROM OTHER CARDS?

A debit card is linked to a checking account; purchases made with a debit card automatically deduct funds from the account. You pay for things with your own funds rather than borrowing them. Some debit cards offer rewards, but they typically pale in comparison to the rewards offered by credit cards. Debit cards also have weaker protections against fraud.

A prepaid debit card is not linked to a checking account; rather, you “load” money onto the card and can only spend that amount. These cards frequently impose fees that you wouldn’t pay with a standard debit card. Prepaid debit cards provide some protections and have restrictions. Some prepaid debit cards, for instance, do not offer ATM access or mobile banking. Additionally, not all retailers accept them.

Debit cards and prepaid cards have no impact on your credit score, as their use does not involve borrowing money. Your credit score will only be affected by a credit card.