What is credit card? A credit card is a small plastic card issued by a financial institution, such as a bank or credit union, that allows you to borrow funds to pay for goods and services. The borrowed funds must be paid back within a set period of time, often with interest.
Using a credit card can provide several benefits. Besides offering a convenient way to pay, it can also help you build credit history, provide purchase protection, allow for emergency spending, and offer rewards or cash back.
Credit cards can vary widely in their features and purposes. Some common types include rewards cards, secured cards, student cards, business cards, and balance transfer cards. Each type comes with its own unique set of credit card terms and conditions.
Understanding credit card terms is essential for responsible use and making the most of your card. Here are some important terms you should know.
Annual Percentage Rate (APR)
The APR is essentially the cost of borrowing on the card if you do not pay off the balance in full each month. It’s expressed as a yearly rate, and includes any fees or additional costs associated with the card. There are different types of APRs – purchase APR (for your normal spending), cash advance APR (when you take out cash using your credit card), and penalty APR (which may apply if you miss a payment).
This refers to the maximum amount of credit that a credit card issuer has made available to you. This limit is determined based on your ability to handle debt, considering factors like your income, debts, and credit history. Going over your credit limit can lead to fees and a potential decrease in your credit score.
This is the period during which you can pay off your credit card balance without accruing interest charges. Grace periods usually range from 21 to 25 days and only apply if you pay off your balance in full each month. If you carry a balance month-to-month, interest accrues immediately on new purchases.
Late Payment Fee
If you don’t make at least the minimum payment by the due date, you’ll be charged a late payment fee. This can also lead to an increase in your APR and potentially damage your credit score.
An annual fee is a yearly charge by the card issuer for the benefits and rewards associated with the credit card. Not all cards have an annual fee. Often, cards with annual fees offer additional benefits or rewards that can offset this cost.
Foreign Transaction Fee
If you use your credit card abroad or make a purchase in a foreign currency, you may be charged a foreign transaction fee. These fees are usually a percentage of the purchase price. Some cards, often travel rewards cards, do not charge foreign transaction fees.
Cash Advance Fee
If you use your credit card to withdraw cash, the issuer will typically charge a cash advance fee. This fee is usually a percentage of the amount withdrawn, with a minimum dollar amount. Cash advances also usually have a higher APR and no grace period.
Balance Transfer Fee
This is a fee charged when you move a balance from one credit card to another, often to take advantage of a lower interest rate. It’s typically a percentage of the transferred amount.
Also called a promotional APR, this is a low or 0% APR offered for a specific period of time after a new credit card account is opened. After this period, the APR will increase to the regular ongoing rate.
This is a higher interest rate that can be imposed if you’re late on your payments or violate other credit card terms. This rate can apply indefinitely or until you make a certain number of on-time payments.
This is a credit score developed by FICO (Fair Isaac Corporation). It’s used by many lenders to determine your credit risk and the likelihood that you will repay your debts. Your FICO score depends on several factors, including your payment history, amounts owed, length of credit history, new credit, and types of credit used.
Important Financial Terms Related to Credit Card
Understanding the financial terms related to credit cards will give you a comprehensive view of your overall financial health. They provide essential information that can help you make better decisions regarding credit card usage and money management in general. Here are some of these critical credit card terms:
A credit score is a numerical representation of your creditworthiness. It’s based on your credit history and compiled by credit bureaus. Factors that affect your credit score include your payment history, the amount of debt you owe, the length of your credit history, the types of credit you have, and how often you apply for new credit. It’s important to maintain a good credit score because it can impact your ability to obtain loans, credit cards, rental agreements, and sometimes even jobs.
A credit report is a detailed account of your credit history, prepared by a credit bureau. This report includes personal information, a list of credit accounts, balances, payment history, inquiries from companies you have applied for credit with, and public records such as bankruptcies or tax liens. You’re entitled to a free copy of your credit report from each of the three major credit bureaus (Equifax, Experian, and TransUnion) once every 12 months.
A credit bureau is an agency that collects and maintains individuals’ credit information, then sells it to other businesses in the form of a credit report. The three major credit bureaus in the U.S. are Equifax, Experian, and TransUnion. These organizations play a crucial role in financial lending by helping lenders decide whether to approve credit card applications, loans, and other credit-related requests.
Debt-to-Income Ratio (DTI)
The debt-to-income ratio is a measure that financial institutions use to assess your ability to manage monthly payments and repay the money you have borrowed. It’s calculated by dividing your total monthly debt payments by your gross monthly income. A lower DTI indicates a good balance between debt and income, and lenders often look for a DTI of 36% or less, though this can vary.
Understanding Credit Card Statements
A credit card statement is a monthly document sent to you by your credit card issuer detailing all transactions you’ve made within a specific billing cycle. It’s crucial to understand the different terms used in your credit card statement as it helps you track your spending, manage your repayments, and spot any errors or fraudulent activity. Here are some of the key credit card terms associated with your statement.
Understanding these credit card terms on your statement is crucial to managing your credit card use effectively. Regularly reviewing your statement ensures you are aware of your spending patterns, can catch any errors or fraud early, and helps you avoid unnecessary interest and fees.
The statement balance is the total amount you owe on your credit card as of your account statement’s closing date. This amount includes all purchases, cash advances, fees, and finance charges that have occurred within that billing cycle. If you pay off your statement balance in full by the due date, you will not incur any interest charges for the purchases made during that billing cycle.
Your current balance, also known as the outstanding balance, is the total amount you owe on your credit card at any given time. It includes your previous statement balance plus any additional charges, minus any payments or credits posted since your last statement. The current balance can change daily as you make purchases, payments, or incur fees.
This term refers to the amount of credit you can still use on your credit card. It is calculated by subtracting the current balance from your credit limit. For instance, if your credit limit is $5,000 and your current balance is $1,500, your available credit would be $3,500. Regularly maxing out your credit card can negatively impact your credit score.
Statement Closing Date
The statement closing date is the last day of your billing cycle. All purchases, payments, fees, and charges made during this cycle are summarized in your statement. Transactions made after this date will appear on your next statement. Understanding your statement closing date can help you manage your spending and timing of repayments effectively.
Payment Due Date
This is the date by which you must make at least your minimum payment to avoid late fees and maintain good standing with your credit card issuer. Paying your statement balance in full by the payment due date allows you to avoid interest charges on your purchases.
Understanding credit card terms is not merely optional; it’s an integral part of maintaining sound financial health. These credit card terms, when understood and used correctly, can guide you to make informed decisions about credit usage, payments, and overall money management.
The vast array of credit card terms may initially seem overwhelming to a beginner. Still, with time and effort, you can gain a solid understanding that helps you leverage your credit cards to your advantage. Knowing these terms can provide clarity on your credit card statement, enable you to prevent avoidable charges, and keep your credit score healthy.
In a world increasingly reliant on credit, recognizing and comprehending credit card terms is an essential skill. Each term serves as a piece of a larger puzzle that, when completed, gives you a comprehensive view of your financial position and creditworthiness.
Therefore, invest the time to become well-versed with credit card terms. In doing so, you’re not just learning jargon; you’re equipping yourself with the knowledge that can lead to financial freedom and success. Knowledge of these credit card terms is the first step towards navigating the complex landscape of credit cards with confidence and ease.