Definition
A credit card is a small plastic card issued by a bank or financial institution, allowing the holder to purchase goods or services on credit. It works under a pre-approved credit limit, which is the maximum amount that a cardholder can borrow. The holder is then obliged to pay back the borrowed amount plus any interest, often on a monthly basis.
Phonetic
The phonetic spelling of “Credit Card” is “ˈkrɛdɪt kɑːrd”.
Key Takeaways
- Function: Credit cards give you access to a line of credit issued by a bank. The cardholder can borrow money for payment to a merchant or as a cash advance, under the condition to pay it back within the specified time period.
- Interest and Fees: If the credit card bill is not paid in full each month, interest is charged on the outstanding amount. Additionally, there may be fees for late payments, cash advances, and exceeding credit limit.
- Credit Score Impact: Responsible credit card usage can help build a good credit score. However, late payments or maintaining high balances can negatively impact the score.
Importance
A credit card is an essential term in business and finance as it is a tool that extends a line of credit to consumers for purchasing goods and services, or withdrawing cash. Its importance lies in the convenience and flexibility it offers to cardholders, as they don’t need to carry cash or have money in their account at the time of a transaction. It offers the ability to make purchases on credit and then pay for them over time, often with added interest. Furthermore, timely repayments can assist individuals in building up their credit scores, which may help them when applying for loans or mortgages. Credit cards also provide added benefits such as reward points, cashback, travel perks, and protection against fraud, enhancing their importance in the finance world.
Explanation
A credit card is a financial tool that allows cardholders to borrow funds with the purpose of paying for goods and services. Credit cards come in handy when individuals need to make purchases or expenses when they do not have sufficient cash on hand. This covers everyday transactions like buying groceries to larger transactions like purchasing expensive appliances or even funding business start-ups. The credit card issuer determines a line of credit, or a limit, which is the maximum amount that can be borrowed. Uses for this borrowed money are versatile as long as they remain within the limit set by the credit card provider.However, credit cards are not merely for achieving short-term financial liquidity. They are also instrumental in helping individuals and businesses build a positive credit history or improve their credit score. This is beneficial for future financial endeavors such as securing loans or mortgages. The credit card operates on a principle of trust where the issuer believes that the debtor can repay the funds borrowed. Regular and full settlement of credit card bills demonstrates financial responsibility and makes it easier to secure higher loans or lower interest rates in future transactions.
Examples
1. Personal Shopping: One of the most common real world examples of credit card use is for personal shopping. Individuals often use credit cards to purchase goods or services, online or in store. For instance, if someone doesn’t have enough cash on hand to buy a new laptop, they can use a credit card to make the purchase and then repay the amount over a period of time. 2. Travelling: Credit cards are often used for booking hotels, flights or rental cars, for the convenience of cashless transactions and also to secure reservations. For instance, a family planning their vacation to Europe might use a credit card not only for the convenience of making payments, but also to benefit from travel rewards or insurance that some credit cards offer.3. Business Expenses: Many businesses use credit cards to manage their expenses and cash flow. For example, a small company might use a business credit card to purchase office supplies or pay for business trips. These cards often come with added benefits like cash back or points that can be used for future purchases or discounts.
Frequently Asked Questions(FAQ)
What is a credit card?
A credit card is a payment card issued by a financial institution, usually a bank, which enables the cardholder to borrow funds to pay for goods and services. The cardholder promises to the card issuer to pay them back the borrowed amount plus any applicable interest and other agreed-upon fees.
How does a credit card work?
When you use a credit card, you are essentially borrowing money from the credit card issuer. At the end of each billing cycle, you are billed for the total amount you spent, plus any interest if you don’t repay your balance in full.
What is a credit limit?
A credit limit is the maximum amount of money that you’re allowed to borrow using your credit card. This limit is determined by the credit card issuer based on factors including your credit score, income, and repayment history.
What is APR on a credit card and why it is important?
APR stands for Annual Percentage Rate, and it is essentially the cost of borrowing money on your credit card. This includes interest rates and any other charges. It is important to understand because it gives you a sense of how costly it would be should you fail to pay off your balance each month.
What are the consequences of not paying off your credit card balance?
Not paying off your credit card balance can lead to a number of negative consequences, including high interest rates, late fees, potential damage to your credit score, and even legal action by your credit card provider if your debt becomes too large.
What is a secured credit card?
A secured credit card requires a cash deposit as a collateral which acts as a credit line for your account. This type of card is usually offered to individuals with low or no credit scores.
What are rewards credit cards?
Rewards credit cards are cards that offer incentives such as cashback, airline miles, or shopping points for each dollar spent. The type of rewards you get depends on the specific card and its associated program.
How can a credit card affect your credit score?
The way you use a credit card can directly impact your credit score. Prompt payments, utilization percentage, length of credit history, and the total amount of credit used are several factors associated with a credit card that can affect your credit score both positively and negatively.
Is it possible to transfer balances between credit cards?
Yes, many credit card companies allow balance transfers. This essentially allows you to transfer your debt from one card to another, often with lower interest rates. However, there might be fees associated with this process.
: What are the common fees associated with a credit card?
: There can be several fees associated with a credit card such as annual fee, late payment fee, balance transfer fee, cash advance fee, over-the-limit fee, and foreign transaction fee. The exact fees depend on the terms and conditions of your specific credit card.
Related Finance Terms
- Annual Percentage Rate (APR)
- Credit Limit
- Minimum Payment
- Balance Transfer
- Grace Period
Sources for More Information
