What Is a Credit Card? Understanding the Basics | Spring Money

Debt is one of the most crucial financial instruments there is, we know this. But we also know that it is extremely easy to get a loan, except for when you actually need it. Most people have been in this position before, where you’re just short of having the cash on hand to afford something but you can’t quite get a loan for it because it either isn’t enough to justify a loan, or you can’t avail one. It’s a complication so infuriatingly frequent to most, so why isn’t there a solution for it? Well, there is. And that is where the credit card comes in!

A credit card, looking just like a debit card, is a plastic made card that fits in your wallet and can interact with the account it is linked to seamlessly. But unlike a debit card, which interacts with an account you’ve put money into, a credit card allows holders to avail products or services on credit and provide holders with flexible borrowing facilities.

How does a credit card work?

The service a credit card provides allows its users to make purchases on credit up to a certain maximum limit free of charge, provided they are able to fully repay the accrued debt at a certain date every month.

After this date, interest will be charged upon the balance periodically and will make repayment gradually more expensive for the borrower. But much unlike loans, credit card users do not have a fixed periodic repayment amount. There is only a set minimum amount they have to repay each month, everything above that being a voluntary contribution to repayment.

A credit card, although an extremely helpful financial instrument, does also present a lot of dangers alongside its benefits. If you fail to meet the required date in which the amount is to be paid back, you can be subject to the vicious cycle of repaying credit card interest rates and default charges along with your accrued debt.

And while there is a minimum amount you can pay; it isn’t recommended to stick to that amount every month as that can be a very expensive way to manage your credit card bills. Paying only the minimum repayment amount will allow interest to continue accruing upon the remaining unpaid balance. And the longer the interest accrues upon the original amount, the longer the debt will last and therefore the infinite cycle of endless interest accumulation begins. This can be avoided by repaying your credit card debts at an amount larger than required each time or ensuring that your credit card dues are repaid in full at the date their due.

What happens if you don't repay the credit card bills?

Defaulting on your credit card bills, alongside being extremely expensive, can also land a severe blow to your credit score. This will affect your ability to withdraw loans in the future, affect your credit limits, affect your trustworthiness by Non-Banking Financial Companies (NBFCs) and even with your future employers/collaborators. Your credit score is a numerical representation of your history with credit, and it depicts your responsibility in paying your bills due. It is recorded for financial institutions to decide if loaning to you is a good bet, and it takes into consideration more than just your credit card defaults.

While there is no specific formula for calculating credit scores, we can still have a generalized idea of how credit scores are calculated. The exact components of which aren’t in the scope of this article (You can find those here), relevant components include your payment history and your credit utilization. Your payment history is pretty straightforward, ensuring timely payment of your loans means that you are more likely to get a loan in the future as lenders are taking on less risk in lending money to you. Your credit utilization factor is less straightforward, as this is less of a hard-and-fast rule. In order to maintain a higher score, ideally maintain using only 30-40% of your credit limit.

In conclusion

Debt is indispensable to building a secure financial future, this makes credit cards an incredibly useful tool as they make the accessibility of debt as simple as the swipe of a card. But for all of its benefits, the concept of debt can also be extremely dangerous for those who don’t know how to effectively utilize it. Thus, making its wide accessibility threatening to those without the knowledge on how to manage it. It is absolutely imperative to understand credit cards and their functions before getting one, as keeping your credit score as high as possible is extremely important.

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