Key Takeaways
- Credit cards provide short-term loans for purchases, adding the amount spent to a credit balance, which users can repay either in full before the due date.
- They offer convenience, rewards, and benefits but require responsible usage to avoid debt accumulation and financial mismanagement.
- Understanding credit card features, types, fees, and interest mechanisms is crucial for effective financial management and maximizing benefits while minimizing costs.
Introduction
It is no secret that every business runs on cash, but do you know what they use to stay afloat when they run out of it? Well, they use a credit card. By leveraging a credit card, they can easily supplement their cash flow. In fact, both modern consumers and businesses rely heavily on them these days, but it comes with a cost, especially for businesses. So, before choosing this financing option, you need to know how it works.
Considering that, our aim is to comprehensively explore credit cards in this article – encompassing their definition, various types, and operational mechanisms. Let’s delve into it to discover how you can optimize the benefits of your credit cards.
What Is a Credit Card?
As the name implies, a credit card gives the user access to a pre-set credit limit that he can use for online and offline purchases and repay it within the defined time period. Credit cards are a form of short-term loan that the cardholder obtains from the financial organization that issues them.
The amount spent by the user using the credit card is added to the credit balance, which the user could repay either in full before the due date to eliminate the interest charges or pay in installments with the interest incurred.
Each credit card has a credit limit, which is the most amount that the bearer may make use of. After considering several factors like income, credit history, and other financial issues, the financial institution sets the credit limit.
When a credit card is used responsibly, the user can raise their credit score and facilitate their application for additional loans. However, credit card misuse can result in heavy debt accumulation as the interest rates would comparatively be on the higher side. Understanding the terms and conditions associated with a credit card is crucial.
How Do Credit Cards Work?
Credit cards serve as convenient tools for paying bills and purchases, whether online or in physical stores. Your credit card information is transmitted to the merchant’s bank when you use a credit card for either of them. The credit card network then grants the bank permission to handle the transaction.
After confirming your details, your card issuer must decide whether to allow or reject the transaction. A credit card empowers you to spend money up to a predetermined limit. You’ll receive a monthly statement detailing your expenditures.
It’s crucial to aim for paying off the entire balance each month. However, you must at least cover the minimum payment, which your credit card issuer sets. Typically, this minimum is around 1% of the outstanding balance, plus any accrued interest, default fees, and the annual charge (if applicable). Often, it ranges between 3 and 5%, or it might be a fixed amount like £5.
Paying the bill in full eliminates interest charges on your borrowing unless you’ve used the card for cash withdrawals. Failing to settle the balance in full incurs interest, usually calculated retroactively from the purchase date.
To mitigate the risk of forgetting payments, consider setting up a Direct Debit. This option ensures timely payments as long as your bank account maintains sufficient funds on the designated date each month, preventing missed payments.
Credit card payment rules:
Considering the payment cycle, credit card payment due date usually falls on the same day of every month or the next business day if in case the due date falls on a weekend or a holiday. The user receives the statement and the bill three weeks earlier in the billing cycle.
There are three types of payments to remember
- Statement balance: This refers to the balance amount at the end of your billing cycle for which you wouldn’t be charged any interest on purchases if you pay your statement balance in full each month.
- Minimum payment: This refers to the lower minimum payment by the due date to keep your account running and this payment also helps you to avoid late payment fees.
- Current balance: current balance refers to the recent transactions made using the credit card after your most recent billing cycle ended.
Where to use a credit card?
Credit cards are versatile payment methods accepted at various locations, such as retail stores, online shops, gas stations, and for services like hotel and travel bookings, salon services and more. They facilitate payments locally and globally, offering convenience and flexibility.
Any business accepting card payments generally accepts credit cards, offering convenience and flexibility to users.
6 Types of Credit Card
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Secured credit cards
Secured credit cards are usually issued to people who are just getting started with credit or to someone who is attempting to fix their credit. To open a secured card, you have to give the card issuer a refundable security deposit or deposit money in an associated bank account. The funds deposited will safeguard the credit limit on the card, and the card issuer may keep the funds if the cardholder stops making payments. Because they reduce the lender’s risk, secured cards are usually easier to qualify for than most unsecured cards.
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Unsecured credit cards
Since unsecured credit cards are the most popular kind, most people choose them when considering credit cards. Users don’t need to keep any money locked to open and use an unsecured credit card. Rather, the credit card issuer evaluates the creditworthiness of your application, which includes your income, credit history, credit score, and other bills, before determining whether to approve or deny it. Maintaining a strong credit score can help you get more cards, higher credit limits, and lower annual percentage rates on your accounts.
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Student credit cards
A student credit card is one of the privilege cards that are issued to students. Student credit cards are similar to unsecured credit cards. Therefore, it would be easy to apply for and obtain a student card as the card issuers would not expect that students would maintain a great bank balance or have a high income or a long credit history. However, most of these cards come with low credit limits.
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Store credit cards
As the name suggests, store credit cards are the credit cards issued by retail stores. Some retailers offer store credit cards to customers to regulate customer retention and improve customer loyalty. These cards usually offer benefits associated with shopping at the store, in various forms like rewards points in the loyalty program or a longer return period for purchasers and more.
Store credit card example: Amazon store credit card issues an unlimited 5% cash back to its users on all their Amazon purchases with an annual fee of $0.
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Reward credit cards
Rewards credit cards are credit cards typically offered by brands in association with financial institutions. Upon using these cards, customers can acquire rewards such as cashback, miles, and reward points. Offering Reward credit cards would help brands enhance customer retention and loyalty.
Reward credit card example: The American Express Platinum Card offers 5X Membership Rewards Points for flights booked directly with airlines or through American Express Travel, up to $500,000 during annual sales. Users who book prepaid hotel rooms through American Express Travel will also get five times as many Membership Rewards Points.
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Business credit cards
Business credit cards help assist small business owners manage their cash flow. These cards are tailored to the needs of business owners. The list of benefits includes incentives in the form of rewards for buying online advertising and free employee cards that are linked to the account.
Pros and Cons of Credit Card
Below is the list of pros and cons of using credit cards
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Pros |
Cons |
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Allows easy and quick transactions. |
The temptation to overspend can lead to debt accumulation. |
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Good use can improve your credit score and financial history. |
High credit utilization or missed payments can lower credit scores. |
|
Offers rewards such as cashback, points, or airline miles. |
Annual fees, late payment fees, and other charges are incurred. |
|
Provides immediate access to funds in times of need. |
Ease of use may encourage impulsive spending and financial mismanagement. |
|
Offers fraud protection and extended warranties on purchases. |
Exposes users to potential identity theft or fraudulent transactions. |
|
Provides a defined timeframe for interest-free borrowing if the balance is paid in full. |
Accrued on unpaid balances, increasing the overall cost. |
Credit Card Charges & Fees
Credit card fees, in general, include:
- Annual Fees: Charged yearly for card ownership.
- Interest Charges: Applied to balances carried over from month to month.
- Late Payment Fees: Incurred for missing payment deadlines.
- Overlimit Fees: Charged for exceeding the credit limit.
- Foreign Transaction Fees: Applied to purchases made in foreign currencies or abroad.
- Cash Advance Fees: Levied for withdrawing cash from ATMs using a credit card.
- Balance Transfer Fees: Incurred when transferring balances from one card to another.
- Returned Payment Fees: Charged for bounced or returned payments.
How Credit Card Interest Works?
The Annual Percentage Rate, or APR, is used to calculate credit card interest on any outstanding debt.
- Monthly Interest Rate: Divide the annual percentage rate (APR) by twelve to get the monthly interest rate.
- Daily Interest Charges: Daily interest is determined by multiplying the daily balance by the daily interest rate.
- Accrued Interest: A certain amount of interest will be accumulated on any unpaid balance from the transaction date until it’s fully repaid.
- Grace Period: No interest is assessed for that billing cycle if the entire amount is paid by the deadline.
- Minimum Payment: Interest is applied if the payment is not made in full, which raises the total amount due.
- Compounding Interest: compound interest charges are added on a daily or monthly basis to the balance, leading to higher overall costs over time.
- Variable APR: Some credit cards have variable APRs, which can fluctuate based on market conditions.
How to use a credit card?
The best way to use a credit card is to use it within the defined limit and pay it back on time. Understanding and managing the credit card payment rules is crucial for responsible credit card use, as they can significantly impact overall costs.
To learn everything you need to know about credit card processing fees, you can check out this guide to credit card processing fees.
How to Apply for a Credit Card?
To apply for a credit card:
- Research: To pick the right card, compare cards against your financial needs and choose the one that best suits your lifestyle. Consider factors like interest rates, annual fees, late payment charges, and other fees associated with the card.
- Check Eligibility: Before you start the application process, ensure you have the necessary personal and financial information, including your full legal name, date of birth, current address, Social Security number, and annual income.
- Application: For a personal credit card, apply online through the financial institution’s website or in person at a branch. You can apply for a business credit card if your company is large enough for which you use an employment identification number (EIN) to. Always keep in mind that your Social Security number may still be needed for business credit cards during the application process.
- Fill out the Application: Provide the necessary details that the financial institution asks for. This information typically includes details like personal information(name, date of birth), financial details, and card preferences.Once you fill out the application form, Follow instructions and submit the application.
- Wait for Approval: The issuer evaluates your application based on the details you have provided and notifies you.
- Receive Card: If approved, the financial institution will send the card to you.
Why Should Businesses Use Credit Cards?
Credit cards play a significant role in the financial operations of businesses for several reasons: For businesses, credit cards offer significant benefits.
Cash flow management: Credit cards empower businesses to manage cash flow with flexibility. Credit cards provide businesses immediate access to funds in time of need. Besides, many credit cards also offer a grace period of around 30 days which also assists them in managing cash flow. Even as credit card transactions are easy to track, businesses can easily monitor their expenditure and manage cash flow.
Convenience: Credit cards play a crucial role in streamlining the purchasing process.Credit cards facilitate businesses to accept payments both online and in-store. This helps in reducing wait times and speeding up the checkout processes.Due to their widespread acceptance as a form of payment, credit cards enable global corporations to grow their clientele.. For businesses that offer subscription-based services, Credit cards also automate recurring payments which help them streamline their billing process.
Tracking: Another significant benefit that credit cards offer businesses is tracking their expenses, which helps them monitor their spending. Credit cards provide businesses with crucial tracking abilities that help streamline financial management and improve decision-making processes. Credit card statements provide a detailed record of every transaction which also includes all the other details like date, amount, vendor information, and more. Mobile apps and internet banking portals allow businesses to monitor credit card activity in real-time. Businesses can quickly detect unauthorized or suspect charges thanks to this instant access to transaction data, which lowers the risk of fraud and minimizes possible losses.
Build credit history:By wisely managing their credit and making on-time payments, businesses can build a strong credit history. Establishing and preserving a credit history—something that can only be accomplished with credit cards—is essential for businesses looking to secure funding, negotiate favorable loan conditions, and establish their reliability as a dependable source of finance.For new or credit-insecure organizations, obtaining a corporate credit card may be the first step toward building credit.
Even as credit cards offer a lot of advantages to businesses, one of the major risks faced by businesses using credit cards is the surge charge fee which usually refers to the additional fee imposed for transactions made during times of high demand. Surge charges are a tactic used by businesses to control demand, offset higher expenses during spikes in usage, or encourage after-hours usage.
How HighRadius Can Help Reduce Credit Card Surcharge Fees
HighRadius provides robust solutions that help businesses reduce credit card surcharge fees besides offering multiple advantages:
Simplified Fee Calculations: HighRadius simplifies the process of calculating fees for various cards, enabling businesses to choose and use ones that have lower transaction costs. With this optimization, businesses can save up to 90% on credit card processing fees.
Level-III Card Processing: HighRadius helps reduce interchange fees by employing Level-III data integration via the EIPP Cloud between your bank, processor, and ERP. This strategy aids in improving customer satisfaction while abiding by fee laws.
Unified Platform for Processing: HighRadius ensures operational efficiency by centralizing credit card transactions onto a single platform, hence expediting order entry. If you choose to impose surcharges, our technology streamlines the entire process by managing and applying these charges to your accounting system in an efficient way.
Seamless Integration: HighRadius easily integrates with banking institutions, credit agencies, payment partners, ERP systems, and other external applications. By doing away with manual entry and guaranteeing a smooth operating flow, this integration guarantees optimized data workflows.
FAQs
1) What is the real purpose of a credit card?
The purpose of a credit card is to furnish users with convenient access to borrowed funds for purchases. It offers flexibility in managing finances, builds credit history via responsible use, and provides benefits such as rewards. It serves as a financial tool for transactions and credit management.
2) What is the difference between credit card and debit card?
A credit card allows users to borrow funds up to a predefined limit, which is obliged to pay back with interest. On the other hand, a debit card instantly deducts the purchase amount by accessing funds directly from the user’s associated bank account every time he makes a payment.
