Definition
A credit card is a tool for buying goods and services in which the cardholder may carryover a portion of the balance to be repaid in future months.
Analysis
A credit card works similarly to a charge card with the added flexibility of a revolving balance. A cardholder may make a smaller minimum payment each month and pay the balance off over time.
There are many different types of credit cards. These include:
- major credit cards
- rewards cards
- gas cards
- store cards
- secured credit cards
Credit cards charge interest on revolving balances, but they do not charge interest when a cardholder pays off the balance in full each month. A grace period allows for the purchaser to repay the debt within approximately 21 days of the closing date without incurring any finance charges. Late payments will incur a late fee.
The minimum payment that is required each month must be enough to cover the finance charges, any fees incurred that month, a portion of the balance (normally 1%) and overdue amounts from previous months. Federal rules eliminated many negatively amortizing credit card products by requiring that minimum payments be set so that a customer can be expected to repay the debt in a “reasonable” period of time.
A borrower may borrow against all of the available credit of the card, but they must avoid allowing the balance to exceed the credit limit. Any purchase, fee or finance charge that causes the balance to exceed the credit limit will result in an over-the-limit fee.
The credit limit and the interest rate of the card are set by the lender at the time of application based on the applicant’s creditworthiness. The credit score and the answers to the application questionnaire are considered in making the decisions to extend credit, to determine the amount of credit granted and to dictate the terms of the credit account.
