You Do Not Know This Much About Credit Cards
Many credit card users are unaware of how credit cards work. They are often influenced by peers who have gotten credit cards or probably crave things they normally can’t afford. Despite the genuine intention behind credit cards, we have heavily abused them.
In reality, credit cards are safer and more convenient than other forms of payment. Therefore, they are highly recommended, provided they are used responsibly.
In this guide, I will explain how credit cards work, address people’s concerns about credit card usage, and explain how to get the most out of them.
Brace yourself as this is going to be a long read. Enjoy!
How Does a Credit Card Work?
The credit card system is slightly complex when we dive into the details. But we can break it into digestible bits. Consider the following scenario.
Assume you went to the store. And you are about to make a purchase. As soon as your card details are logged into the store’s payment system, your card information is sent to the store’s bank in no time. The store’s bank then seeks authorization from your credit card company to complete the transaction.
Among other things, your credit card network then examines your credit score, credit limit, debt repayment punctuality record, and many others.
If you qualify for the transaction, they make the payment to the store, and the credit amount is added to your existing credit balances.
All of what I mentioned above happens within a few seconds. And again, it’s only a big-picture view of how the credit card system works.
Once your billing cycle ends, your card issuer sends you a statement summarizing your transactions, your previous and new balances, and your minimum payment due date.
Credit Cards Vs. Debit Cards
To understand both terms, we need to think of them in the context of a real-life situation.
When you use your credit card to make purchases, you are essentially borrowing someone else’s money with the intention of repaying it later, possibly with interest.
The opposite is true for debit cards. When you use your debit card to make an online purchase or pay for a service, you are actually spending your hard-earned money. This is because your debit card is tied to your primary bank account.
Debit and credit cards also differ in terms of credit score.
For example, your debit card usage has no impact on your credit card rating. This is because credit reporting agencies (organizations that gauge people’s credit scores) have no access to your bank account activity.
On the other hand, credit card usage directly impacts your credit score. As a result, the more you use your credit card, the more your credit score dips.
Interestingly, there are two main credit scoring models: FICO and VantageScore.
What’s The Difference Between the FICO Score and VantageScore?
FICO score and VantageScore are the most common credit score rating models. Also, they tend to move in the same direction. So, for instance, if your VantageScore is on point, you will likely have a great FICO score.
Although FICO and VantageScore use nearly identical data, they draw different conclusions and insights based on certain factors.
Take, for example. FICO credit scores estimate your scores based on the following factors:
- Payment history
- Credit usage
- Credit age
- Credit mix
- Inquiries for new credit
By the way, credit cards possess one advantage over debit cards, which is fraud protection. Credit card companies and federal law agencies ensure fraud protection over credit cards.
As a result, you won’t be responsible for any damages if your credit card is breached.
How To Avoid Interests On Credit Cards
Paying off your monthly statement balances within the grace period is one of the best ways to avoid paying interest on credit card purchases and incurring debt.
Paying on time protects you from excessive interest and increases your credit score and limits.
What Do I Mean By “Grace Period”?
For credit cards, the grace period refers to the period of time between the consumer’s monthly statement issue date and the payment due date. However, the grace period only applies if you paid the previous credit card in full and on time.
Generally, a credit card’s payment due date takes only about three weeks.
What Do I Mean By “Credit Limit”?
The term “credit limit” refers to the maximum amount of money a financial institution can loan a consumer. Credit card companies determine your credit limit. Furthermore, the credit limit is determined by information provided by you and other consumer credit reporting companies.
Credit financial institutions consider factors such as your credit rating, average personal income, and loan repayment history obtained from credit reporting companies.
Equifax, TransUnion, and Experian are the three most popular and credible credit reporting companies.
But then, your credit limit depends largely on your ability to pay back within the given timeframe.
Credit Card Debts
Credit card debts are outstanding balances incurred by failing to fulfill your minimum monthly dues. This type of debt boasts of one of the financial industry’s highest interest rates.
However, to be on the safe side, it’s best if you pay off your balances within the grace period and save against future interest.
What Is the Average Credit Card Debt?
Based on the 2019 Experian Consumer Credit Review, an average American owes about $6,194 in credit card debt.
To put this into perspective, this is what an average Nigerian family, far back in West Africa, makes every 6 months.
Suitable Credit Card Advice For Young Adults With No Credit History
Young adults are in the habit of making regretful mistakes. One of which is the irresponsible use of credit cards. Don’t get me wrong. Credit cards are not inherently bad, but many people have abused their intended purpose. As a result, if you fall within this age range or even have children in this age range, they must understand the following:
1. An understanding of how a credit card works.
2. The relationship between their credit card usage and credit score
3. An understanding of how debit cards are different from credit cards.
Credit Card Tips To Build Credit Score
Building your credit score is difficult, especially if your credit card history is terrible. However, you can always regain the trust of financial institutions by implementing the tried-and-true strategies outlined below:
1. Pay bills on time.
2. Do not be greedy.
3. Do not abuse the privilege.
4. Maintain a low balance-to-limit ratio
5. Limit your requests for new credit
The Bottom Line
Ultimately, the purpose of a credit card is to make payments more convenient and secure. Not to satisfy your impulses or accumulate unnecessary debt. For this reason, pay your bills on time, improve your credit score, and buy only what you can afford. Do this and be sure to live a happy life.
My best wishes are with you as always. Love, Daniel.
In subsequent articles, I will explain every single subtopic in detail. So, stay tuned.
