What is Credit Card?

A credit card is provided by financial institutions or banks, which permits a person to borrow money on a preapproved limit for purchases on a credit basis. The credit limit is decided by the institution and bank which issues a credit card depending on the person’s credit score and income. A cardholder can use the card for credit purchases, a balance transfer, cash advances.

How does a Credit Card work?

The credit card issuing bank or financial institution lends money to the cardholder as a short-term loan and permits them to make purchases and pay back the loan later. Most cards provide a grace period. A grace period falls between the billing cycle and the due date of the payment. When a holder pays back the full balance on or before the due date then no interest will be charged on new purchases. If the holder fails to repay the whole balance amount in a grace period or due date then interest will be charged on the remaining unpaid balance. Interest is calculated based on the annual percentage rate (APR) which differs from bank to bank. The holder will get a credit card statement each month which allows checking the history of the transaction, minimum payment, due date, and the balance. The financial institution which issues credit cards is the master card, visa, discover, American express. Bank also relies on these companies to process the payments.

Types of Credit Cards

The different types of credit cards are used based on the customer preference they can be availed. The following are some of the different credit cards that are used

  • Balance Transfer.
  • Low Interest.
  • Cash Back.
  • Hotel/Travel.
  • Airline Specific.
  • Business.
  • Student.

Balance transfer credit card

A balance transfer credit card consolidates existing credit card balance onto one card and allows to pay it down faster. Usually, customers use balance transfer cards to transfer the balance of higher interest-rated credit cards to the lower-interest-rated credit cards. Most credit card companies initially offer balance transfer cards with an introductory 0% annual percentage rate for a period between 15 to 21 months, which helps in avoiding the payment of interest charges. Most cards require to pay a 3% - 5% fee for the balance transfer, also there are credit cards available without a balance transfer fee. By using a balance transfer card, a person can save money during the interest-free period and also get additional perks on purchases.

For example, the wells Fargo cash-wise Visa card offers the best balance transfer card for digital wallet users with 0% APR for the first 18 months after it charges about 14.29%-24.99% as an annual percentage rate.

Low-interest credit card

A low-interest credit card initially offers a low introductory annual percentage rate for a certain period and changes to a high-interest rate after a certain period. It is useful for the customer who makes large purchases because it offers several months to pay back the amount with low or no interest.

For example, Citi double cash card- offers an attractive introductory annual percentage rate on balance transfer and double cashback.

Cash back credit card

Under the cashback credit card, the holder receives cash or other rewards at the time of making purchases. Rewards can be in the form of money or bonus points, points are redeemable in the online marketplace where the card issuer operates.

For example, a person uses a cashback credit card with a purchase reward rate of 1.5% and makes $200 in purchase then he would earn $3 cashback as a reward bonus.

Hotel / Travel credit card

Hotel or travel cards allow enjoying rewards on specific purchases made in travel-related purchases. The points or rewards are redeemed in co-branded hotels. These types of cards are available in co-branded, non-co-branded varieties.

For example, the marriott bonvoy brilliant™ American Express card offers for marriott purchases and mid-tier gold elite status with perks like room upgrades and the opportunity to earn bonus points.

Airline specific card

Airline-specific cards are given by one particular airline. Where customers use to purchase air tickets and get benefits as mile rewards. It also provides perks like attractive bonus sign-up, priority boarding, free checked baggage, etc.

For example, southwest rapid card priority credit card which is a visa card it offers to earn 3X points on dining, takeout, and delivery services and gives 2 points per $1 spent on Southwest® purchases as a bonus.

Business card

A business credit card helps a consumer to maintain a separate credit transaction from personal and business activities. It gives benefits like a low introductory rate, cashback rewards, and airline rewards especially for businessmen, etc.

For example, Ink business unlimited credit card offers 0% ARP for 12 months for account creation on purchases, after it charges between 13.24%-19.24% annual percentage rate with no annual fee. It also provides an unlimited cashback of up to 1.5% as a bonus on each purchase for business activities.

Student Card

Student credit cards are created especially for college students who do not have a credit history. It helps to complete education and also allows to make necessary purchases. Most of the student credit card does not charge any annual fee and gives rewards for a good score in exams. It helps the student to build a good credit history if it is used wisely.

 For example, the petal 2 visa credit card – offers 1%-1.5% cashback and 2%- 10% bonus cash back for some merchants with an annual APR of 12% to 26.99%, and no fees are charged.

Advantages of using credit card

There are many advantages to using a credit card. The usage of credit cards instead of ready cash or personal saving funds offers the following advantages:

Building credit history

Using credit cards for paying bills and making purchases helps to build up a good credit score, which will lead to access to better loans and mortgages.

Emergency funds

Credit cards act as a financial safety in case of insufficient funds to pay bills on time or for an emergency purchase.

Rewards and bonus

Most banks and financial institutions offer rewards in points and bonuses, cashback offers, discounts, gift vouchers for every transaction.

Disadvantages of using credit card

Even though are benefits to using credit cards there are some disadvantages also. The following are the disadvantages:

High Rates of Interest

The credit card is subject to a high rate of interest in case of default payments when the amount is carried forward from months to months.

Annual Fees

In most banks, the annual fee can be higher for some types of credit cards. Generally, card which has more rewards and perks have higher annual fees compare to other cards.

Credit Damage

Late payments and default payments will directly impact by reducing the credit score which will affect the chances of getting better loans.

Context and Applications

This topic is significant in the professional exams for undergraduate postgraduate courses for Bachelor of Accounting and Finance, Bachelors in Banking and Insurance, Bachelor of Commerce, Masters of Accounting and Finance, Masters in Banking and Insurance, and Masters of Commerce.

Practice Problems

Question 1: Which credit is used to transfer debt from one card to another credit card?

  1. Balance transfer credit card
  2. Airline credit card
  3. Student credit card
  4. Business credit card

Answer: Option 1 is correct.

Explanation: Balance transfer credit has the only feature of transferring debt from one card to another credit card.

Question 2: Default credit payment reduces _________ of card holder

  1. Transaction limit
  2. Credit score
  3. Credit limit amount
  4. Interest rate

Answer: Option B is correct.

Explanation: When a cardholder does not pay the payment on time his credit score will be reduced.

Question 3: A credit card act as a _______ in case of insufficient funds in hand.

  1. Debit card
  2. Helper
  3. Longterm loan
  4. Financial security

Answer: Option A is correct.

Explanation: Credit cards act as financial security when no sufficient funds are in hand.

Question 4: Which of the following credit cards is suitable for Traveler?

  1. Student credit card
  2. Business credit card
  3. Hotel credit card
  4. Cash back Credit card

Answer: Option C is correct.

Explanation: A traveler goes to a different place to rest the travel to rest himself he can use a hotel credit card.

Question 5: Which of the following offers cashback for purchase?

  1. Business credit card
  2. Cash back credit card
  3. Airline credit card
  4. All of the above

Answer: Option D is correct.

Explanation: To attract the customer's business credit card, cash back credit card, an airline credit card gives cashback offers at least percentage for every purchase.

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