What Is a Credit Card and Why Do You Need It

What You'll Learn
How a credit card works.
Why credit cards are beneficial for both banks and those who use them.
What is a credit card and how does it work?
A credit card is a payment card with bank money on it. If you pay for something with a credit card, borrow money from the bank, you need to pay it back.

You can pay with a credit card wherever bank cards are accepted: on the Internet, in stores, restaurants, pharmacies. From the store's point of view, the money on a credit card is just money. But there is a difference for you.

Despite the fact that the item bought with a credit card becomes yours, the money spent on it is not yours, but the bank's. The amount you borrowed from the bank is called debt. The bank may charge a fee—a percentage of the debt—for lending money. Or maybe not: in this lesson, we will tell you how to use the bank's money for free.

There is money in the bank on the credit card. When you spend it, you borrow it from the bank.
To understand how a credit card works and why it can be beneficial, you need to know what a credit limit, credit history, interest rate, and interest-free period are. It sounds scary, but it's actually simple. Let's find out.

WHAT THE
Credit limit
This is the maximum amount that can be spent with a credit card. It is set by the bank individually: you can have one limit, and your neighbor in the same bank has another.

Banks do not recognize how they calculate the credit limit, so there are no specific formulas. It is only known that the credit limit depends on various factors, including credit history and monthly income.

Usually, the approach is as follows: the more a person earns, the more money can be lent to him. If the monthly income is low, the bank may refuse to issue a credit card or offer a small limit.

The bank can increase or decrease the credit limit on a credit card that has already been issued. For example, you have been cooperating with the bank for a long time and repay loans on time. The bank understands that it can trust you and raises the limit.

Credit limit is the amount that the bank has entrusted to the client

Credit history
This is a dossier on you as a borrower, your "karma". Your credit history contains information about closed and open loans, loans, and credit cards.

Banks know you from your credit history. They open it and see that the person pays all obligations without delay. This means that this is a solvent and responsible client – you can trust them with money.

If a person repays debts late or does not pay at all, the bank will not entrust them with money. Or they will trust you, but set a very low credit limit, for example, 500 dollars.

Interest rate
We have already said that usually the bank lends for a reason, but for a fee – a percentage of the debt. The interest rate determines how much interest on the amount of debt you will have to pay to the bank. The good news is that most credit cards have an interest-free period when you don't have to pay for using the bank's money. We'll come back to that later, but for now, let's just break down how this interest rate works.

In loan agreements and credit card advertisements, an annual interest rate is indicated, for example, 20% per annum. Even if you take out a loan for a couple of days, the contract will still indicate the rate for the year. This is the way it is supposed to be by law.

Interest-free period

An interest-free period is sometimes referred to as a grace period and a grace period – they are the same thing. Almost all credit cards have it, but it differs: somewhere up to 50 days, somewhere up to 100. And in general, it has a lot of subtleties and nuances that you need to know. Therefore, we will talk about the interest-free period in a separate lesson.

Using a credit card outside of the interest-free period is a bad idea: you will have to pay interest to the bank. Moreover, the rate on credit cards is very high – much higher than on ordinary consumer loans. If you need money for a long time, it is more profitable to just take a loan from a bank.

How does the bank make money on credit cards?
It may seem that the bank is distributing money for free on cards with an interest-free period. In fact, the bank earns even when it seems that it is operating at a loss.

This is how the bank makes money on credit cards.

Accrues interest to someone. Not all people manage to repay the debt in full before the end of the interest-free period. Many people forget, do not have time or simply cannot put the required amount on the card on time. In such cases, the bank charges interest as if there was no interest-free period.

Charges a fee for servicing the card. The client pays a fee to the bank for the opportunity to use the credit card. It can be accrued every month or once a year.

There are cards without commission, but with mandatory conditions. For example, the service is free if you spend at least 500 dollars from the card monthly. And for each month when the costs are less, you will already have to pay a commission.

Charges the seller a fee for transferring money. For example, you went to the store and paid with a credit card at the checkout. For you, everything happened simply and quickly, but in fact, complex financial magic happened. The bank has withdrawn money from your card and transferred it to the supermarket's checking account.

This service is paid for by the store, not the customer. The store receives the amount minus the commission, which averages 2-3%.

It takes money from the cardholder for additional services. Banks like to automatically activate paid services, such as SMS notification or insurance. Therefore, read everything you sign, even if the bank manager assures you that these are standard documents. Otherwise, you may accidentally subscribe to a service you don't need.

If a bank employee imposes something on you you don't need, ask him: "Is this a prerequisite? If I don't agree to the additional service, will you give me a credit card?" Most likely, it will immediately turn out that "this is all voluntary, if you don't want it, whatever you want, here's your card."

Perhaps they will try to gently but persistently convince you that "this is the way it should be, just plug it in, and you can disconnect it at any time." Don't be fooled: it's easier to cancel an unnecessary service right away than to figure out how to turn it off and get your money back.

It charges the owner of the credit card a commission for individual transactions. There are paid transactions that can be made with the card, and there are free ones. If you pay for your purchase with a credit card, the bank will not charge a commission for this - this is a free operation. The bank can only demand interest – and then only if you do not have time to return the money before the end of the interest-free period.

Usually, paid transactions include cash withdrawals and money transfers to another card. This is no coincidence: the bank earns every time you pay for purchases with a credit card. And when you withdraw money from the card, he does not receive anything.

Why Credit Cards Can Benefit You
Now let's talk about your benefit from credit cards.

Free money. Almost all cards have an interest-free period. You can use the bank's money free of charge if you pay it back before the end of the interest-free period.

Cashback. The bank rewards customers for actively paying with credit cards. It looks like this: you buy something, and the bank returns you a percentage of the payment back. Such a refund is called cashback.

In fact, cashback is a discount that is given not at the time of purchase, but later. First, you pay the full cost of the purchase, and only then the bank returns part of the money from it.

Cashback is paid in cash or bonus points. You can spend the money however you want, but bonus points are only for what the bank offers.

You could use another credit card where the cashback is higher - 2%, but it is paid not in rubles, but in bonuses. This is not always convenient for everyone, because bonuses can only be spent on something specific.

Discounts and gifts. The bank's partners can provide discounts and gifts to cardholders, such as free travel insurance, discounts on taxis and car sharing, and others.