How does a Credit Card Work

What happens when you find exactly what you have been looking for over the last six months, but at a time when you are short of cash.  For most of us, that means flashing the credit card.  It is one of the most popular and convenient way to borrow money to fund purchases. They allow you to purchase goods and services and pay for them at a later date. The card provider pays the required sum to the retailer and the credit card holder then repays the sum owed to the credit card provider. The card holder does not have to pay the full amount owed in one payment, they may spread the repayments over a number of months. The card provider will charge interest on the outstanding balance for allowing this facility.  Some credit card providers will also charge an annual fee, which will usually come with some other benefit, such as a bonus points system.

The use of credit cards, even though one of the most expensive ways of borrowing money, is extremely high.  The main reason for this is the convenience of being able to purchase without pre-arranging a loan and the flexibility of being able to pay over a number of months at your own discretion, within the requirement to make a minimum payment each month. Also, the use of credit cards for remote shopping, across the internet or by phone, make them almost a necessity in this technological age and the advent of so many goods and services available online.

When you think about whether to hold a credit card, and if so how many to hold, consider that when you borrow money on a credit card, there are rules that you must follow:

a)     there will be a minimum amount that you must pay the provider each month, usually expressed as a small percentage of the outstanding debt, eg 5%.b)     you will be provided with a credit limit and this is not to be exceeded.  The limit will depend on your income and the card provider’s evaluation of your ability to repay the loan.

b)     there will be charges added to your balance if you do not adhere to the repayment date quoted on the statement that you receive from your provider every month.

c)     you must pay interest on any outstanding balance (this interest is usually very high compared with other forms of borrowing but people tend to be happy to pay this in exchange for the convenience of the credit card).

Also remember that credit card providers are businesses which are established to make profits.  They do this by ensuring that they receive more money in repayments than they pay out in loans.  A large part of achieving this requires them to encourage you to keep a balance on your card on which you will pay interest.  They have a vested interest in ensuring that it is difficult for you to pay back the money you spend in one repayment.  This is important to remember if you decide to hold more than one credit card, as you will have minimum repayment requirements for each card and you may find it difficult to cover even minimum repayments on all of these every month.