What Is a Credit Card: How it Works, Types, Pros, and Cons

Did you know that one of the very first references to credit cards came from the 1887 novel “Looking Backward” by Edward Bellamy? He mentions the phrase 11 times and although he doesn’t refer to the cards we have today, but something more similar to debit cards. 

Today, there are billions of credit cards used all around the world. But how much do you really know about that rectangular piece of plastic in your wallet? 

In this blog post, we take a closer look at what is a credit card and what are the ins and outs of it to make their world more understandable.

What Is a Credit Card?

A credit card is a physical card issued by financial institutions like banks. In simple terms, it’s a plastic card that conforms to global ISO standards for banking and it enables users to make purchases or withdraw cash by borrowing funds from the bank. Credit cardholders are then charged an interest rate and other fees for the cost of borrowing money.  

In general, a credit card has the following characteristics: 

• EMV chip;
• The cardholder’s name and account number;
• Card expiration date;
• Issuer logo;
• Card scheme logo;
• Magnetic strip;
• Customer service number;
• Signature box;
• CVV number;

The latter four features appear on the back of the credit card while the first five are located on the front side of the card. 

How Credit Works

While these are the physical characteristics of a credit card, you might also wonder how credit works. 

A bank, financial institution, building society, or another card issuer may offer cardholders access to a separate cash line of credit (LOC), which is a pre-established credit limit. By doing this, credit card issuers allow cardholders to borrow money as cash advances via bank tellers, ATMs, or credit card convenience checks.

This line of credit needs to be paid back in instalments over time with, in most cases, some type of interest rate. You can also do a cash advance, which is withdrawing funds from your credit card, but be aware that the charges for this can be quite high. 

It’s important to note that according to laws and regulations, credit card issuers are obliged to provide a minimum of a 21-day grace period before cardholders are required to pay interest. Naturally, this makes paying off balances prior to the expiration of the grace period a good idea for any credit cardholder. 

In cases when the balance is not paid in full, cardholders may be required to make a minimum payment (a minor percentage of the outstanding balance).

Make sure that you understand the interest accumulation methods that your card issuer works with, especially if you plan to send your credit card balance to a card with an interest rate that’s lower. 

Next, let’s take a closer look at what types of credit cards you can get.

Types of Credit Cards

Credit card holders around the world can make use of different types of credit cards.For example, popular options like Visa and Mastercard are provided by banks, credit unions, and other financial institutions. 

Here are some of the different credit card types along with their peculiarities: 

• Balance Transfer: has an introductory interest rate and, most times, it offers “a lower fee on balance credit card transfers.”
• Rewards: offers credits for goods or services. These can range anything from airline travel, to hotel stays, and even cashback. The rewards you receive will depend on how much you spend with the corollary that the more you spend, the higher the rewards you earn.
• Premium: although these types of cards usually come with higher annual fees, they offer perks that don’t really come with regular credit cards. With such cards, you could enjoy special events, concierge services, access to airport lounges, additional insurance coverage, and even retail.
• Retail: issued usually by a large retailer or store. It is usually specifically limited to making purchases at that retailer and it often gives the cardholder a discount on the first purchase.
• Secured: usually issued in the US and are mainly used by people with lower credit scores. In order to use your card, you need to prove that you have the funds first. This means that you’ll need to put down a cash deposit before you can use this type of card at retailers or stores. On the other hand, unsecured credit cards don’t come with any obligations when it comes to security deposits or collateral. 
• Credit Builder: ideal for individuals with a low credit score. This type of card helps them build a stronger credit rating, as it helps them use the credit allocated responsibly. Typically, these cards have borrowing limits that are lower than usual and charge interest rates that are higher than most, acting as an incentive in a way of responsible borrowing.
• Overseas / Travel: perfect for overseas travel because they rarely incur overseas fees. They are great for managing your holiday expenses as well as avoiding reliance on cash when you’re abroad.  

When choosing a credit card, keep in mind to examine the fees and rewards included with each type of card. 

Advantages and Disadvantages

There are many benefits of credit cards and some drawbacks. So, if you’re thinking of applying for a card, keep the following list of advantages and disadvantages in mind. 

Advantages of Credit Cards

Beyond the inherent advantages of credit plans, financial institutions use various incentives to attract new cardholders and create new benefits for users. 

For example, if you do your homework right, you may even find a credit card that offers you zero percent interest on purchases or balance transfers for periods between 12 and 18 months.

Below, you’ll find some of the main advantages of using a credit card. 

Earn Rewards

Some credit card issuers appeal to users via extra bonuses or rewards, like airline miles, gift certificates, and others. This refers to what we know as rewards credit cards, which allow you to earn rewards or the so-called “loyalty points” when you make purchases. 

Such points can add up to more benefits for you as these can include cashback or even discounts at selected retailers.

Make Emergency Buys

Accidents happen all the time and more often than not, they’re unexpected. If you don’t have a large savings fund, credit cards can be really useful if your car breaks down and you need an emergency fix or another type of emergency crops up that you have to deal with.

You can rest assured that your unexpected situation will be addressed while paying the amount off in instalments at a later date. 

Spreading the Costs Around

Some credit cards also offer you deals with zero or small interest rates for the first couple of months. This means that you can buy something expensive when you get your card and pay it off interest-free for the first few months while this offer is still available. 

However, make sure you pay off the amount during this period, as after that, interest will be charged. 

Debt Consolidation

If you have a lot of debt and you’re looking for ways to manage it, a credit card can come in handy.

For example, if you get a credit card that offers lower interest rates than the debt you’re carrying, you can pay off the debts with your credit card and have one lump sum to pay off over a period with lower interest rates.

Payment Protection

Some credit cards also offer you protection on your payments if you make a purchase and the merchant you buy from goes under and cannot deliver. 

However, you need to check that your provider offers this option and the minimum and maximum amounts covered. 

Strengthen Your Credit Rating

Making sure that your credit card purchases are within your budget means that you won’t fall into the scenario of credit card debt – an important element of your credit score. 

A strong credit score means you’re more likely to be approved for a credit request such as a loan for a home. However, if you don’t yet have a credit history, or you’ve defaulted on loans in the past, this may be a bit more difficult to get.

Therefore, credit builder credit cards come in handy, as they help you use the credit responsibly while you build a reputation for yourself in terms of how you manage your money.

Track Your Spending

Your bank, financial institution, or building society that issued you with your credit card should send you a credit card statement each month. 

This monthly statement, as well as the online portal of your issuing institution, will help you keep track of your expenses.

Fraud Protection

Credit cards are regulated and governed by policies like the Consumer Credit Act. Typically, they come with more fraud protection when compared to a general debit card account. 

For instance, the majority of credit card issuers provide free liability protection over a certain time period. In the case of debit cards, liability is based on your response to a lost or stolen card and how urgently you deal with the situation. This means your liability declines if you’re the victim of fraud. 

Convenience

The technological innovations that we’re witnessing today make the use of credit cards more convenient and reliable than ever.

You can now add your credit card to your digital or mobile wallet and spend that way instead of having to carry and pay with cash. All you need for this is your smartphone!

Zero Interest or Annual Fee

Do your homework right and you may even find a credit card that offers you zero percent interest on purchases or balance transfers for periods between 12 and 18 months. 

Some credit plans may even offer programs with no annual fees. Of course, what you ultimately find as beneficial depends on your needs. 

Disadvantages of Credit Cards

There are also downsides to using credit cards, however, and you should weigh up the advantages and disadvantages and the overall credit card cost to you.

According to researchers, the use of credit cards leads to a sort of “abstract” pain of payment. This may cause people to spend more than they have, which is just one example of a potential negative of credit accounts. 

In the following paragraphs, we will explore the other disadvantages of credit cards. 

The Inevitable Fees and Interest Rates

Yes, there are fees with credit cards. These credit card fees can range from annual, balance transfer, foreign transaction fees, late payment fees, and fees for when you reach above your credit limit. 

Credit card companies also charge interest rates on using their services. These are considered some of the highest interest rate debts consumers can access.

You Can Run Up Debt

Because money isn’t automatically deducted from your bank account, you run into the situation of spending more than you have. 

This can increase your overall debt and it’s a growing concern in many countries around the world. 

Bankruptcy

Credit card providers often offer attractive interest rates in the first few months. 

However, these rates jump up rather steeply after this period, which can cause many people who do not budget effectively to be driven to bankruptcy. 

Merchants Who Pass the Buck Onto Consumers

Every merchant that signs up to offer card acceptance services essentially pays a transaction rate to their card acceptance services provider.

However, to make up for this transaction rate, some merchants can hike up their costs, passing them down to consumers. This can ultimately lead to inflated pricing for consumers.

Disclaimer: Please be aware that the contents of this article and the myPOS Blog, in general, should not be interpreted as legal, monetary, tax, or any other kind of professional advice. You should always seek to consult with a professional before taking action, since the particulars of your situation may materially differ from other cases.