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An Explanation of Credit Cards and Related Issues

By: , dated January 25th, 2013

Credit cards are an extremely useful way of paying for products and services. They are often more convenient than cash or checks, and they are almost universally accepted (including over the phone). Additionally, they are a great way for you to establish your creditworthiness. And some cards offer additional benefits, such as rebates, frequent flier miles, and insurance.

But credit cards are a mixed blessing. They can encourage excessive spending (which often results in serious financial pain for those who carry balances). Also, the interest starts accumulating immediately for new purchases on credit cards with balances. Additionally, unlike most loans, credit card debt doesn’t have a required repayment schedule, which can be a temptation to pay only the minimum amount required and never pay off the full amount owed. The system is designed this way; credit card companies make most of their profits from cardholders who pay just the minimum amount required, since they charge exorbitantly high interest rates on the money owed.

We recommend credit cards only for those who intend to pay off the balance each month. Let’s face it: It can take just a few months to get into financial trouble and years to get out. Those who don’t pay off the entire balance every month get penalized in two ways:

  1. they continuously pay interest on the outstanding balance, plus
  2. they pay interest immediately on any new purchases (as opposed to those who pay the balance each month, who are extended a grace period during which no interest is charged).

Although debt is sometimes useful, there is a difference between good debt (a home, car, education, etc.) and bad debt (money borrowed with no specific plan of repayment, such as with credit cards, debt consolidation or overspending in all areas of a budget). Even though debt is a part of life, the key to preventing it from becoming destructive is knowing the benefits and hazards of using credit.

In the United States, Visa and MasterCard are the two most common brands of credit cards. However, neither Visa nor MasterCard actually issues their cards. Instead, they provide advertising, credit authorization and record keeping services for their partners, who are authorized to issue the cards and specify the terms of their programs. This is why there are so many different credit card offers, and why it’s important to shop around.

Types of Credit Cards

In addition to standard credit cards, you should also consider three other types of cards: a debit card, a secured card, and a non-revolving credit card.

  • With a debit card, you don’t actually have a line of credit extended to you. Instead, you make purchases with money that’s already in your bank account. That way there’s no risk that your card use will put you in debt, because your usage is limited to the amount you have in your account. Debit cards come in two types: direct (which requires a PIN for use) and deferred (which requires a signature for use). The deferred card is accepted at a larger number of locations. One drawback is that you’ll need to record each transaction in your checkbook, so you’ll know how much you have left in your account to write checks against. In addition, debit cards don’t offer a grace period as some credit cards do, and some issuers charge a fee each time you use the card.
  • With a secured card, you have a collateral savings account backing the card. This gives the card issuer some protection, since they will be able to liquidate those savings and apply them to the balance if you default on your credit card payments. Secured cards are common among consumers who have poor credit or no credit, and can’t get a standard credit card (yet).
  • With a non-revolving credit card, you can make charges just as you would any other credit card, but you have to pay your balance in full every month. Of course, you have the option to pay your balance every month with any credit card (and in fact that’s what we recommend), but for a non-revolving credit card it’s a requirement. The most popular non-revolving credit card is American Express.

All three cards are designed to prevent the cardholder from running up credit card debt, and for this reason we recommend them, especially for anyone who doesn’t feel completely in control of their spending habits.

This article was brought to you by the InvestorGuide Staff Writers and Editors.

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