Credit Card Analysis
A small, rectangular piece of metal or plastic that is provided by a bank or other financial services provider.
What Is a Credit Card?
A credit card is a small, rectangular piece of metal or plastic that is provided by a bank or other financial services provider. Cardholders can use their credit cards to borrow money to pay for products and services from businesses that accept credit cards.
Cardholders can make purchases using credit cards issued by banks or financial services. Credit card users borrow funds from their bank and use their cards to purchase goods and services from merchants that accept them.
Cardholders are given credit limits based on their income, and their relationship with lenders is represented by a credit score. These cards are either plastic or metal.
Financial institutions often offer these cards with rewards like welcome offers, along with cashback and reward miles. People with bad or little credit history can usually only get secured credit cards.
A card requires cardholders to repay any borrowed money, plus interest and additional fees, in full by the billing date or over time. Issuers use individuals' credit ratings to set borrowing limits.
The card issuer may also grant cardholders a separate cash line of credit (LOC), enabling them to withdraw cash from bank teller machines, ATMs, or convenience stores.
The terms of cash advances are usually different from those of credit cards that access the main line of credit, such as no grace period and higher interest rates. An individual's credit rating determines a borrower's borrowing limit.
In general, interest charges are imposed about one month after purchase on any unpaid balances charged to the card (except when the account is opened with an introductory 0% APR offer for a limited time).
There is no grace period for new charges unless previous unpaid balances have been carried forward from a previous month.
Key Takeaways
- A credit card allows cardholders to borrow funds from a bank or a financial institution to make purchases.
- Cardholders must repay the borrowed amount along with interest fees if a balance is carried over into the next billing period.
- The benefits of these cards include ease of use, building credit history, providing emergency funds, paying for things at a later date, and earning rewards such as cashback or points.
- They have drawbacks such as high interest rates, debt accumulation, fees, and penalties. Misuse can harm credit scores and affect borrowing options.
- There may be foreign transaction fees, annual fees, late payment fees, and different interest rates for purchases and cash advances on these cards.
- Limits on the cards indicate how much a cardholder can spend. Maintaining a healthy credit utilization ratio is essential to improving credit scores.
- Many effective strategies to manage card debt include debt consolidation, debt snowballing, and debt avalanche reorganization.
Types Of Credit Cards
There are various types of credit cards to cater to various specific financial or personal needs. The following shows the various cards available.
1. Rewards Credit Cards
They offer many incentives to attract customers, such as airline miles, free access to airline lounges, hotel room rentals, and cash-back discounts on purchases. These cards are often called reward credit cards.
2. Cash-back credit cards
To develop and maintain customer loyalty, many retailers issue branded cards with store names emblazoned on the face of the cards.
For example, Chase Bank and Amazon.com jointly issued a co-branded credit card called Amazon Prime Rewards Visa Signature Card. Cashback is earned at Amazon.com and Whole Foods Market, 2% at restaurants, gas stations, and drug stores, and 1% everywhere else.
3. Starter credit cards
Cards with secured deposits are those where the cardholder secures the card with an upfront payment. People with poor or limited credit histories frequently apply for these cards.
4. Secured credit cards
Secured cards require security deposits or collateral, while unsecured cards don't. Cardholders with these cards tend to have higher credit lines and lower interest rates than those with secured cards.
5. Debit cards
Similar to a secured card, a prepaid debit card is a type of secured payment card with its available funds matching those in the linked bank account. Cardholders can transact by deducting funds from their main or linked bank accounts.
Credit Card Vs. Debit Card
The following highlights the main differences between credit and debit cards.
| Aspect | Credit Card | Debit Card |
|---|---|---|
| Meaning | Payment card that allows cardholders to borrow money up to a limit to make purchases. | The payment card allows cardholders to make purchases with the amount present in their account. |
| Usage | Used for making purchases by borrowing funds from the bank. | Used for making purchases using the amount present in the cardholder’s account. |
| Spending limit | Spending is allowed beyond the current balance. | Limited to available funds. |
| Risk | There is a risk involved in accumulating debt if not managed properly. | Lower risk of accumulating risk. |
| Impact on credit score | Can positively or negatively impact credit scores. | A credit score is not affected. |
| Reward programs | Various benefits and program plans are available. | Limited programs are available. |
Credit Card Benefits and Drawbacks
Let's take a look at some of the benefits of credit cards:
1. Convenience
They offer convenience and are widely accepted. By eliminating cash, they allow quick and easy in-person and online transactions in various locations.
2. Credit Building
Credit history records how a person has borrowed and repaid money. Lenders utilize credit history to determine whether a person is suitable for credit cards and loans. Also, it helps them determine which parameters they should assign (i.e., the interest rate and credit limit).
Responsible use of credit improves the quality of life and gets you closer to your financial goals.
3. Emergency Funds
They can provide financial security in an emergency. When unexpected expenses arise, they can provide immediate access to funds, providing a temporary solution until other financing or payment methods can be arranged.
4. Rewards Programs
They often offer rewards programs, such as cashback and travel rewards. The holders who actively use their cards can benefit from these rewards and save money.
The drawbacks of these cards are:
1. High-Interest Rates
Non-payment of these card balances each month will accrue interest charges. In comparison with loans or mortgages, these typically have higher interest rates. As the card debt accumulates, interest costs can become significant.
2. Debt Accumulation
Using the cards improperly can lead to excessive debt. In addition to high balances, overspending and relying on them can quickly accumulate debt that is hard to repay, resulting in financial stress and credit score damage.
3. Fees and Penalties
Some cards charge annual, late payments, balance transfers, and cash advance fees. Overspending credit limits or failing to meet payment deadlines can result in additional penalties and negatively impact credit scores.
4. Impact on Credit Score
Misuse of these cards, such as consistently making late payments and exceeding credit limits, can harm credit scores. Loans and mortgages with a low credit score are likely to have higher interest rates and fewer borrowing options.
Credit Cards Charges And Rates
Using a credit card involves paying interest to the company for the privilege of borrowing money. The annual percentage rate is usually expressed as APR. It is common to have variable APRs that fluctuate with a particular benchmark, such as the prime rate.
Some cards charge multiple interest rates, which complicates matters even further. As a result, they can charge one rate for purchases but another (usually higher) for cash advances.
The cards may have the following charges and rates:
- Foreign Transaction Fee: When one uses this type of card in a foreign country or abroad, the banks may charge a foreign transaction fee. This fee is generally a percentage of the transaction amount as it covers the currency conversion and processing costs.
- Annual Fee: Annual fees are charged on certain cards to maintain the card's privileges. These fees can vary depending on the various types, features, and benefits the card may offer. It is, therefore, important to consider the annual fee when choosing this type of card.
- Interest Rates (Annual Percentage Rate - APR): Interest is charged when a card’s balance remains unpaid after the due date on the statement. These cards express Interest rates as annual percentage rates (APR). Market conditions, as well as your creditworthiness, can influence your card’s interest rate.
- Overspending Fee: Overspending on your card may result in a fee. If you exceed your credit limit or make purchases with an overdue balance, you will be charged a fee.
- Late payment fee: This fee is charged when a card payment is late. In general, card issuers charge late payment fees that are a fixed amount. These card bills must be paid on time to avoid these fees and adverse effects on credit scores.
Credit Card Companies and Networks
There are four main credit card networks in the United States, with Visa and Mastercard being accepted more than the others, especially in foreign countries.
1. Visa
Having become one of the world's most popular payment networks, Visa has become a household name. Visa cardholders are offered a wide variety of benefits around the world, making their cards more popular. Visa cards are widely accepted around the world.
2. MasterCard
As with Visa, it facilitates transactions and provides credit and debit cards. MasterCard offers consumers a wide variety of products to meet their needs.
Among American credit card networks, MasterCard ranks second after Visa. It allows you to do online banking and protect yourself against fraud.
3. Discover
Discover, a U.S.-based credit card company, comes with several credit card options. The company is known for its cash-back rewards program, promotional offers, and outstanding customer service.
4. American Express (Amex)
Amex is both a payment network and a credit card company. Their premium and rewards-focused cards include travel rewards, cash back, and exclusive benefits.
In addition to the four main networks, there are many credit card issuing companies. Since Visa and Mastercard are processing companies but not issuing companies, they partner with financial institutions that issue the credit card itself.
It is important to understand the distinction between these companies so that you understand which companies are competing with one another. Additionally, you can determine which card and company is the best for you.
Because there are a wide variety of companies and types of cards, selecting a credit card for you can be daunting. Comparing different cards and their benefits is important, but applying to cards that fit your credit history is most important.
Note
Hard credit card inquiries that result in declined applications will greatly affect the applicant’s credit score.
Some popular credit card issuing companies consist of
- Chase
- American Express
- Discover
- Capital One
- Citi
- Bank of America
- Wells Fargo
- U.S Bank
- Barclays
- Other local or special opportunities
As seen in the companies mentioned throughout this section, some companies serve as credit card issuers as well as network providers.
American Express, for instance, issues credit cards but also has its own network of credit cards.
Conversely, some companies join to create a card. For example, Chase and Wells Fargo both partner with Visa, a processing network, to have their credit cards with the Visa processing network.
On top of this, credit card companies can partner with other companies, such as hotel or airline companies, to generate rewards specific to those companies.
Credit Limits And How They Are Used
Credit limits are the maximum amounts individuals can spend on a particular credit card or revolving line of credit. Both secured and unsecured credit can be subject to credit limits. The lender can offer a higher limit if the line of credit is secured or backed by collateral.
The card balance limits are influenced by several factors, including the consumer’s ability to repay debt, company cash flow, and firm cash flow capacity. To determine whether or not a borrower is eligible for credit, credit scores are used, which are calculated by institutions using the above-given factors.
Note
Low credit limits may be imposed if one indulges in overspending, so it may be difficult to pay monthly bills. Lenders may use this source of information to determine whether to extend new credit and what interest rate to charge.
The credit utilization ratio indicates how much one owes relative to the amount of credit available, which is a key element in one's credit score.
In other words, the credit utilization ratio is how much of the credit limit is used each month. This percentage should be lower and below 50%.
For instance, the card balances are $2,000, and the credit limits are $10,000. Therefore, the credit utilization ratio would be 20% ($2,000 / $10,000 * 100).
Credit scoring models such as FICO and VantageScore consider credit utilization as a main factor when assessing creditworthiness.
Low credit utilization ratios can positively impact credit scores, while high utilization ratios can negatively affect them.
By reducing your debt level, you can improve your credit utilization ratio. Credit utilization ratios will also improve if you receive more lines of credit that divide up the balances, creating lower utilization ratios.
Credit Card Incentives and Rewards Programs
A rewards program may offer cash back, tangible benefits such as airline miles, no interest for a limited period or low-interest rates, or discounts and special rates on travel and travel accommodations.
A description of the various card incentives and rewards programs can be found below.
1. Cash Back on Purchases
Cardholders receive cash-back rewards for a percentage of their purchases. It is possible to earn higher cashback percentages with some cards when purchasing groceries, dining, or gasoline.
The Citi Double Cash Card can earn 2% cash back - 1% when making purchases and 1% when paying on the account.
2. Gift Cards
This type of physical card comes pre-loaded with a predetermined amount. Some various retailers and categories offer gift cards that can be redeemed at specific locations.
If a customer spends a specific amount within the first few months of activating their card, the issuer may reward them with a gift card to a popular retail store.
3. Travel Rewards
Travel reward cards let one earn miles or travel points for every purchase you can redeem for flight tickets, hotel stays, rental cars, etc. Using Chase Sapphire Preferred as an example, can be used to redeem for travel-related purchases.
4. Introductory Rate Period
Credit cards sometimes offer 0% APR on purchases and balance transfers during their introductory period. A promotional period can benefit those looking to make large purchases or consolidate their high-interest debt without accruing interest.
This means cardholders can make a large purchase or pay off their existing debt without worrying about the associated interest costs for the promotional period.
5. Membership Rewards
Membership programs offered by some card issuers can offer exclusive benefits, such as concierge services, purchase protection, extended warranties, and exclusive events. Cards used actively are eligible for these programs, which offer exclusive benefits and rewards.
Managing Credit Card Debt
It can be challenging to manage card debt effectively. Managing these card debts and their repayment is crucial for maintaining financial health and avoiding financial hardship in the future.
One can manage credit card debt by following these strategies:
1. Consolidation of Debts
Consolidating debt is a financial strategy that involves combining multiple debts into one manageable loan or credit card.
Having a lot of high-interest debt, one will benefit from multiple cards that offer a low annual percentage rate (APR). Consequently, the interest costs can be reduced, and your payments can be simplified.
2. Debt Snowball Method
This method focuses mainly on paying off your small debt. As soon as the smallest debt is paid off, roll the remaining amount into the next smallest debt. Seeing debts being paid off one by one provides psychological motivation.
Behavioral economists believe that eliminating small debts early gives people a sense of progress and relief, which keeps them motivated. This method may not be the most cost-effective for some because focusing on the smallest balance can grow your debt exponentially.
3. The Debt-Avalanche Method
Debt avalanche, also known as debt stacking, is a method of paying off debts with the highest interest rates first. A person with multiple cards with different interest rates should pay off the one with the highest interest rate first.
A debt avalanche may be a good option for those who want to pay off debt quickly and inexpensively.
Using the debt avalanche method minimizes your interest payments over the course of repaying your debts. It can save money in the long run by prioritizing your debts according to their interest rates.
4. Balance Transfer
Good credit scores qualify one for a balance transfer card that can help pay debt faster. With a balance transfer of these cards, you can transfer your balance from one or more cards to another with an introductory 0% interest rate.
One will save money on interest while transferring high-interest credit card debt to a promotional rate card. However, remember to pay off the balance before the promotional rate expires to avoid any balance transfer fees.
5. Budget Your Spending
Avoid making new purchases on cards while paying off debt. Make sure you do not add to your deficit but reduce it. Paying off debt quickly can be achieved by allocating extra cash every month.
Having a well-structured budget for your expenses is helpful for making the best financial decisions and avoiding overspending. The key here is to find new ways to save by setting up a budget, tracking your spending, and reducing unnecessary expenses.
This ensures you make timely payments and allocate a portion of your budget to decrease outstanding balances.
Conclusion
In conclusion, cards allow cardholders to borrow money from banks or financial institutions, which must be repaid along with interest and fees. These cards offer benefits such as convenience, building a credit history, emergency funds, and rewards programs.
Despite their advantages, credit cards have drawbacks, such as high interest rates and debt accumulation.
There is a wide variety of credit cards, and the benefits that come with them can depend on the relationships the banks have with different programs and companies. There are travel rewards cards, cash-back cards, and starter cards, which are all available to people as long as the lender approves their credit score and income.
The points you earn from rewards cards can be redeemed for gift cards, merchandise, and travel. Cash-back cards offer a percentage of your spending back as cash. Starter cards are designed for people with no credit history, which usually have lower limits, lower reward multipliers, cash-back percentages, and higher interest rates for missed payments.
A positive credit score depends on maintaining a healthy credit utilization ratio and credit limits on cards.
To ensure a positive credit score, cardholders should maintain a healthy credit utilization ratio and credit limits, as well as budgeting, avoiding overspending, and paying bills on time.
You can manage card debt effectively with debt consolidation, debt snowballing, balance transfers, and debt avalanches. Maintaining financial health and improving credit scores requires budgeting, avoiding overspending, and paying bills on time.
Cards offer consumers many benefits, such as convenience, building a credit history, emergency funds, and rewards programs.
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