Introduction to Credit Scoring
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Introduction to Credit Cards
Just the basics, basically.
Introduction:
Ever found yourself in a situation where you suddenly needed to book a flight, stay at a hotel, rent a car, or make an emergency purchase? Are you interested in starting your own business? Or, have you ever wrestled over the decision whether or not to use a shady ATM? These are common problems, with a common solution: credit cards.
What Are Credit Cards?
A credit card is more than just a piece of plastic in your wallet; it's a versatile financial instrument that provides convenience, security, and rewards for responsible users. Unlike debit cards, which directly withdraw funds from a bank account, credit cards grant access to a line of credit - a revolving spending account - funded by the credit card company. When you make a credit card purchase, you are essentially borrowing money from the credit card company. They front the funds, and you pay back the borrowed amount at the end of the month. If you don't, your agreement with the credit card company allows them to recoup the borrowed funds, plus a little extra, in the form of fees, interest charges, and penalties.
While this arrangement may seem as simple as any other loan, credit cards come with many, many more strings attached. Before applying, it's critically important to understand how they differ from other loans. Otherwise, you may face unpleasant surprises.
Why Get One?
“I don't use a debit card. The safest thing is a credit card because you're using the bank's money. If someone accesses your information, they are stealing the bank's money, not yours.”
Frank Abagnale, Jr. – Fraud Expert and Ex-Con Artist
The benefits of using a credit card extend far beyond simple convenience. If you're still on the fence, we'd like to share some of the more-compelling reasons:
Establishing Credit
A good credit history shows lenders that you reliably repay your debts. Credit cards are the most accessible way to improve it. It's important because the quality of your credit history largely determines the ease (or difficulty) of making major life purchases like housing, or a vehicle. With a good credit history, your credit company will vouch for you in the market, at large. When it’s finally time for a Really Big Purchase, your financial institution can prove you’re good for the small, regular payments that car dealers and landlords expect as part of a financing arrangement. But, a credit reference is only one of many benefits of a good credit history. With a positive history of timely payments, you'll qualify for successively better, and lower, interest rates.
Rewards
Credit cards are perhaps best known for the wide variety of discounts, rewards, and perks they offer to beguile users into spending more. Make no mistake: credit card rewards programs are entirely subsidized by interest collected from irresponsible borrowers, and they effectively pay for themselves. It doesn't actually cost the credit card company anything to offer rewards. But, responsible users are able to reap real value from them. Some of the top-tier, super-prime cards offer annual rewards with an actual-cash-value in the thousands.
Fraud Protection
Robust fraud protection is one of the top advantages credit holds over debit. In the event of credit card fraud, consumer liability is typically limited to a maximum of $50, as mandated by U.S. law. Many card issuers even offer zero-liability policies, ensuring their customers won't lose any dime to unauthorized transactions. On the other hand, debit card fraud is typically far more problematic. The Electronic Fund Transfer Act stipulates that consumer liability is zero, only if the card was reported stolen before any unauthorized purchases are made. However, most people won't notice their information was stolen until a fraudulent transaction actually happens. Once that happens, you have two business days to report the theft. If more than 48 hours go by, you become personally liable for up to $500 of the fraud.
Still Not Convinced?
What if you waited even longer? What if the fraudster (like most) only uses your card for small, local, routine purchases that you already make? Things like gas, groceries, entertainment…
Debit cards, unlike credit cards, mostly lack fraud-detection mechanisms. Aside from the excruciatingly-boring process of going over your statement, line-by-line, it’s difficult to notice when a little money goes missing. But, if you report debit card fraud more than 60 calendar days after the statement date, you become entirely responsible.
In fact, the FTC says that if you don’t notice someone’s been stealing from you within 60 days of the first theft, you then become responsible for “all the money taken from your ATM/debit card account, as well as any funds drained from accounts linked to your debit account – including investment accounts, savings accounts, and the like.”
Truly a nightmare scenario. Unfortunately, at least 1 in 20 of our readers will have dealt with financial identity theft in the last year alone. Among them, one in four is a repeat victim. If you’re casually using a debit card out in public, please stop. Even the simplest credit cards offer better protection.
Can CardClub Help?
If you're considering getting a credit card, it's crucial to do so responsibly. At CardClub.com, we believe in providing equal access to credit. We also believe it's our duty to ensure readers are ready to handle the responsibility that comes with it. There are 5 basic prerequisites you should meet before seeking out a credit card. Don't start shopping until you've...
Established a predictable annual income.
Created a sustainable personal budget.
Secured an emergency fund of one month's expenses, based on that budget.
Determined if you are living within your means, above them, or below.
Eliminated any pre-existing high-interest debt.
Credit cards are immensely secure, and the convenience they offer can tremendously simplify life. But, they come with their own set of risks. The convenience credit cards offer is a double-edged sword, as it's extremely easy to overspend. High interest rates are a major drawback, and most credit card companies generate significant profits from compounded interest and late payment fees. It's also challenging to close a line of credit once it's been opened, and doing so can damage your credit score. Again, it's essential to prepare before embarking on this journey.
Ready to Dig In?
If you're ready to explore the world of credit cards further, our next article in this series covers Credit Scores. In it, we'll provide the critical context you need to begin comparing credit products. For more insights and advice on making the most of your credit card experience, explore CardClub's Editorial Hub.
Related Topics
Understanding APR
Credit cards are a special type of loan known for imposing heavy interest, in exchange for the freedom they provide. In order to compare cards, it's key to understand interest, APR, and how they relate.
Fees and Charges
Credit card companies employ a bevy of tactics to profit off the convenience offered by their product. Fees, penalties, and surcharges all come with the territory. Don't be caught unaware.
