Interest and Loans: Credit Card
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Credit cards are a popular way albeit tricky way to pay for expenses. They're also one of the best examples of applying interest to debt.
How Credit Cards Work
Aside from referring to the plastic card one swipes through an electronic device to verify the card and charge the purchase to it, the term credit card also refers to the system that uses such a card. The most interesting thing about using a credit card is revolving credit. One can use the borrowed amount (only up to a certain amount called a credit limit) available; this credit may increase or decrease depending on the amount that has already been repaid. It is unlike closed-end loans that disallow further "rounds" of borrowing and one is often encouraged to charge purchases to credit because of this.
This makes credit cards different from debit cards, which are designed to subtract the amount you spend using them from one's checking or savings account, and charge cards, which charges no interest but obligates the holder to pay the outstanding balance of the account on a regular basis (usually monthly), often to prevent overspending.
Payments, as you may have expected, are based on the funds that have been used up plus interest, as the cost of borrowing that money from the credit card company. One can choose to pay in small amounts, subject to a minimum payment requirement stated in his/her monthly credit statement, or pay the whole debt and more, if possible.
Credit Card Interest
It has been pretty clear to us how interest, in pretty much any loan, is the cost of getting access to a sum of money that one would rather have at the moment but cannot have otherwise. Every borrower (or spender) considers it the trap they fall into after spending too much, but from the lender's perspective, it is a way these credit card issuers create revenue; otherwise there wouldn't be enough to lend to everybody. It is also their "reward" for the "risk" that they are taking in lending their funds to other people. Factors such as the borrowing history of the candidate credit cardholder, as well as other financial information gathered from him/her through documents and interviews, help determine the interest rates that are acceptable for them.
The different methods for charging interest include average daily balance, adjusted balance, previous balance, two-cycle average daily balance, daily accrual and others.
Penalties
There are host of fees that banks can charge its cardholders. A large part of them are penalties for paying the dues late, paying more than the required monthly payment, being unable to pay the full amount due in the monthly statement, and exceeding the credit limit.
Canceling and Change in Loans
Expect banks to change the terms/conditions that apply to a credit loan. One is notified within a month or two; if he/she does not agree to the changes, usually the debt must be paid off in full. It is important to understand and remember the conditions that both the lender and the borrower have agreed upon because violations to that contract such as those that cause penalties can also cause banks to cancel a loan.
Interest-Free Promotional Rates
Banks can offer special interest rates as a promotional offer to attract potential customers and increase their income. The interest rates are very low, sometimes zero or interest free, but only for a certain period. There is also an underlying agreement one must comply with, such as a deadline to pay off the amount borrowed under that agreement, otherwise the cardholder would have to pay for penalties. One must clearly understand the terms and conditions of the promo before jumping in since it is easy to obscure the actual amount you're paying in the long run.
Points and Rewards
Another popular form of promotion with credit cards "reward" worthy cardholders merchandise, airline miles, discounted interest rates, gift certificates, cash, or others when they have reached a certain number of points (or miles or pennies), which are gained when they use the credit card to make purchases. Sometimes these points can even be exchanged among different banks and entities that are participating in the rewards program. They also add value to a credit card option because of the convenience and rewards that can be gained by choosing that particular deal over others.
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