A credit card is a financing instrument issued by a creditor that allows the authorized cardholder to finance the purchase of products or services or, in some cases, a cash advance.The credit card is actually the physical representation of the line of credit made available to the cardholder.
Most credit cards in circulation today are revolving accounts. With revolving debt, the outstanding balance can increase or decrease, based on items purchased with the card and payments made by the borrower toward the credit card balance. Additionally, the required payments on credit cards are will also fluctuate based on the account’s balance. In contrast, installment loans have set payments structured to consistently and gradually decrease the loan amount.
Consumers and businesses have a wide array of options when it comes to credit cards. However, not all of credit cards function the same way. The following are the three basic types of cards used by credit users today:
As the use of standard credit cards have proliferated, several new variations of the standard type of credit cards have entered the market:
Just as with most loans, a credit card is issued to an individual or company only after the creditor has reviewed, underwritten and approved the credit card application.
Each creditor or financing company establishes its own underwriting criteria and lending guidelines. Although many credit card companies do look for good to excellent credit, some credit card programs (such as secured credit cards) do accept applicants with damage credit or low FICO credit scores.
When a consumer makes a purchase with a credit card, the credit card company electronically transfers or directly deposits the amount of the purchase to the merchant’s account, less a processing fee paid to the credit card issuer (by the merchant). This “merchant fee” is one reason why many vendors and merchants prefer cash or debit cards.
When the consumer signs the receipt for the purchase, he or she is making a promise to repay the credit card company based on the terms of the original credit agreement that the borrower signed with the creditor. The credit agreement will identify the interest rate, the due date, and the minimum payment due with each statement.
The creditor can adjust the credit limit as well as other terms of the loan agreement over time, and with notice, based on the consumer’s payment history to the creditor and overall credit profile. For example, say a new credit card customer has a credit limit of $500.After a period of charging goods and services and making timely payments, the credit card issuer may increase the credit line to $1,000.With continued timely payments and a good credit history with other creditors, the credit limit may be increased further still.The consumer can also request an increase in credit limit at any time, though the creditor always has the prerogative to accept or decline that request.Once the request is made, the credit issuer will evaluate recent payment patterns to determine whether a new credit limit can be offered.
Late payments on credit cards have the reverse effect. If the consumer begins to make payments past the due date, the credit issuer can raise the interest rate on the card or lower the credit limit.If the consumer misses payments or defaults on the credit card agreement entirely, the card issuer may cancel the credit card completely and proceed to collect the outstanding balance due from the consumer.
Credit cards are a staple in the modern world of consumer finance, providing a convenient way to purchase goods and services from merchants across town or around the world. Used responsibly, credit cards can also be one of the most effective ways to establish good credit.
Disclaimer: NetCredit is a direct personal loan provider and does not provide financial advice, nor does it vouch for any vendor or service mentioned on our NetCredit personal finance blog or online consumer loan glossary. Always research and perform due diligence on any service provider or vendor before deciding to use them, and we recommend that you speak with a financial advisor regarding all decisions that will affect your finances.