How does Credit Cards Work | Guide for Beginners
If you don’t have any money but still want to spend money like a boss then Credit Cards may come handy for you. The basic idea is that your card issuer (a bank or NBFC) borrows you an ATM card which has some money in it. You can spend that money with a promise to repay back. Let’s uncover How does these Credit Cards Work.
This article requires you to have basic banking knowledge, if you are an absolute beginner then kindly read this article to get through the basics of banking like interest rate and Fixed Deposit. I have used plain English to explain that stuff, even 10-year old kids will understand.
Moving on, I hope you have ever heard about a Debit Card. You can take a debit card to the ATM machine and after some button clicks, the money will be withdrawn from the linked bank account. POS Machines are also available to directly pay at the shops without withdrawing the cash.
The debit card solves the problem to go to the bank for withdrawing cash from a Savings Bank Account. Think of the credit card to solve the same problem in case of a Loan Account.
What is a Credit Score?
Basically, you need to have a good Credit Score to get a Credit Card. There are different credit bureaus in different countries. Those guys collect your Debt details from all banks and keep a central record. Actually, Banks give you the credit simply based on your promise to pay back. There are chances that you can default. So each time, you go to them for a loan. Your Credit Score is Checked.
Suppose, you default at Bank A and then ask for a loan at Bank B. That won’t work. After the default at Bank A, your credit score will be lowered and this results in you getting abandoned at all financial institutions for any future loans until you improve the credit score.
There are many ways in which credit score influences your financial life. Sometimes, it’s possible that after defaulting at a bank, you won’t be completely banned. But will experience an interest rate hike while applying for another loan. It’s just as complex as it may sound.
This ideally moves us closer to the real question that How does Credit Cards work. You now know that you need to have a good credit score whose record is maintained by the credit bureau of your country.
How to apply for a Credit Card?
Basic KYC (Know Your Customer) details are required to apply for the credit card. Depending on the country and credit card institution, there can be a variation in the requirement of documents. For eg., In India, you just need an Identity Proof, Tax ID and Income Proof.
With these, you may walk to a bank or call their online representative. They will collect the documents and check your credit score. On the basis of that score, you will be offered various credit cards. If you have a good credit score then cheers! You will get low-interest rate schemes and higher spending limit.
Higher limit means more money in your card. After you choose a plan for your card, the issuer institution will complete your application. Time is taken to complete the process largely varies from bank to bank. Some of them can instantly activate your card whereas others will take days.
Now due to digitalization, you will most likely receive some credentials to log into the net banking and/or mobile banking platform of your credit card agency. You will find your transaction statements there.
There is also a chance that along with the physical credit card, you will get a digital credit card in the mobile banking app. Every information you need about your credit card service will be available in that app.
How to use a Credit Card?
It is simple. You can withdraw cash from an ATM with your credit card, swipe it on the POS machine and also do a digital transaction. If you are a tech first person then these pretty pieces of plastic can be quiet beneficial for you. Because mostly there are no charges if you use the card for a digital transaction and pay back on time.
Similar to a normal debit card, there will be a 16 digit number of Credit Card, an Expiry Date, and a CVV code. To transact online put those numbers into place and boom! it will be done. The beauty of credit cards is they don’t make you feel that you are spending any money. It’s even scientifically proven.
Some stores even provide exclusive offers for credit card users. You can use your card there to get some cash back. In my opinion, these are just ways to make you use the card more. So in summary, similar to a normal debit card. You can use your credit card to pay for anything unless the spending limit runs out.
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How to repay the money back to the bank?
You will get a statement in your email inbox at the start of each month. This mail will include all your transaction details along with the total bill and charges if any for the past month. Now, the cardholder needs to pay the bill and charges within a grace period.
Grace Period basically means a time period in which you can pay the credit card bill and you won’t need to pay any interest rate. It can last from 7 days to a complete month. In case, you can’t pay within the prescribed Grace period then cardholder has the option to pay a minimum amount and then the bank will incur interest on rest of your borrowed amount.
This way credit cards are a short term debt instrument. If everything stays fine then credit card debt is returned to the bank within a month or two. That’s why I called it short term.
Honestly, it won’t be wise to discuss the repayment structure in great detail here because it can differ largely from one bank to other. I hope you have got a basic idea about it. We all know that Banks haven’t opened their offices for charity. So Now let’s talk about charges.
Which Charges will you incur?
There are banks which make their customers pay a number of charges whereas some others claim not to charge anything. One thing is sure that you need to pay some interest which depends on your Credit Score. So, it’s best to improve that first rather than jumping from one bank to another.
Basically, you can incur Late Fee if you don’t pay the bills on time. A Card Reload charges when you reach your spending limit. There is also a Credit Card issuance charge. Balance Transfer Charges and what not. Some banks can also ask you to pay an Annual Fee. This list can go long as I had stated earlier.
One Sentence Answer – It Just Depends. Look for a Credit Card Institution which charges you the least. It’s no way good to pay money just for the sake of some fancy facilities. Be Wise.
Why Credit Card is good?
Credit Cards basically come with all the benefits of a usual ATM Card. There are just a few differences here and there. Let’s try to discuss that in detail here.
1. Easy to Use and Carry Around
This is just the basic bull shit feature which every credit card company will tell you. I am no different. It is something small, thin and light that can be easily carried in your purse or handbag. It will help you to get those paper money notes with the help of an ATM machine. Sounds like magic, Right?
Seriously, cards can be magical because if they somehow eliminate all the world’s cash then governments can save tons of money from being wasted on printing and managing their respective currencies.
2. Free if you are WISE
Here, I have written the word ‘Wise’ in caps to indicate its weight. You really need to be a calm, wise and disciplined person to enjoy the free usage of a Credit Cards. Look, some companies don’t charge anything if you pay them back within the grace period.
So, you need to choose a card from that company and make sure you never miss the deadline for payment each month. It sounds simple but can be hard. Active Research has this proven over the years.
Taking the last point to a new level. You can actually make your bank pay you some money. It’s rarely possible practical because of human nature but still, I will share the trick. It has been found that humans spend more using credit cards.
So, to make people use these cards more, bank tie-up with store owners to give special discounts to people who use credit cards. This works great for the Store Owner as well as Banks. But, if you are smart then you can make it work great for you too.
The trick is to use the card only when you are getting a reasonable amount of discount and cashback on something you really need. And right after the purchase, you should repay the credit card. This way you will get some extra discount and won’t risk anything at all.
Why Credit Cards are Bad?
Every good thing has an opposite side too. Same applies to Credit Cards also. In fact, the bad effects of credit cards are more severe than the goodness of their goodies for most, normal people.
1. Hight Interest Rate
This is really a deal breaker. A normal credit card holder will pay around 24 per annum interest rate in case of a credit card. This range drops a lot if we a personal loan instead of the credit card. One thing is that you will incur the interest rate only if you don’t return the money within the grace period.
As explained earlier, it depends on your credit score and your spending discipline. Credit Cards can make you suffer the worst but can also prove a good thing if used appropriately.
2. Debt Spiral can bankrupt you
I think banks love Compounding and they can use it more wisely than anyone on this earth. So, if you don’t pay a charge for one month then interest rate costs can dramatically increase.
Suppose, your card has a spending limit of $1000 and you used $5000 in the past month. Now, as times are tough, you are not able to pay back. So, you do the minimum payment and then start paying monthly installments.
This can get trickier. The mathematicians at the bank can charge you more interest than the amount you even owed at the beginning. This is why banks always give you the option to pay the minimum amount because that way, they will earn the most.
3. Spending Habits
It is a simple scenario. If you have some extra money and want to buy something then you are most likely to buy that. Moreover when you are rewarded (with discounts and cashback) to buy stuff then literally nobody can stop you.
This finally leads to extra expenses and in some cases, bankruptcy. That’s why I always prefer to stay away from this plastic card. You can save some money and then buy whatever you want. Never use the credit card route to calm your materialistic fire.
Is it a good choice for normal people?
It depends. If you are a calm, happy person who is already satisfied with his earnings then STAY AWAY. Or else, if you are up for an adventurous ride in which there is a chance to get bankrupt then thumbs up! Credit Cards are for you.
It has been a matter of debate for years if credit cards need to banned or not. But as governments are earning hefty sums of money from this. There doesn’t seem any chance of a ban.
I have an opinion that your financial planning decides if you will end up being a bankrupt or millionaire. We have written a very easy step by step guide on that topic. I know for sure you will love that. Read it here.
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