A credit card can be one of the most useful and convenient forms of payment you’ll ever use. Unfortunately, many people misuse credit cards without knowing how to use them properly. And that can lead to serious financial problems down the road.
If you want to use credit cards correctly and avoid the financial dangers associated with them – it helps if you understand what a credit is, what it’s used for and what its limitations are.
Here are some basic credit card facts you should know if you plan on adding some “plastic” to your wallet or handbag:
What is a Credit Card?
If you think a credit card is a plastic card with a bank’s logo and embossed numbers on it – you’re right (on a superficial level). But exterior appearance aside, credit cards are simply another form of payment that allows you to borrow money from a Financial Institution (FI) or bank.
Unlike a loan, which is a long-term form of borrowing, a credit card allows you to borrow typically a smaller amount that you’ll pay back over a shorter amount of time.
While every bank has its own categories of credit cards, the most common credit card issuers include:
- American Express
To get a credit card, all you need to do is fill out an application at a bank (at a branch office or online). Once your application has been evaluated and approved, the bank will provide you with a line of credit showing you exactly how much you can borrow (ex. $1,500).
The bank will then send your credit card in the mail. Oh, and don’t forget to sign the back when you receive it!
How Can You Use a Credit Card?
Once you get your credit card in the mail and activate it, you’re free to use it at a variety of ways. Just make sure you don’t go overboard by going on a mall shopping spree the same day you receive it!
Remember, a credit card let’s you BORROW money that’s not yours – you still have to pay it back!
Here are some common ways credit card users put their cards to work:
- Make purchases at local or overseas retail establishments
- Make online purchases
- Pay your bills
In regards to where you use your credit card, keep in mind that certain establishments (online and physical stores) will ONLY accept credit cards from certain financial services brands – the biggest being MasterCard, VISA and American Express (AMEX).
If you have an AMEX credit card and want to buy a shirt from a retailer that only accepts VISA cards, you won’t be able to make the transaction.
That’s why many credit card users prefer to have a mix of at least VISA and MasterCard credit cards just in case a retail establishment only accepts a certain brand.
How Do Credit Cards Work?
Before you start swiping your credit card at every retail establishment that has a giant SALE! sign on its windows – take a moment to understand exactly how a credit card works.
Here’s a general step-by-step process of how credit cards work:
Step #1 – The Handover
After flirting with the cashier for a few minutes, you decide to pay for your purchase and hand your card over to make payment.
Step #2 – The Validation
The cashier will then swipe your card, which submits your account information over a secure internet connection. During this process, the retailer will validate your account and settle with the issuing FI or bank whether to let the purchase go through.
If a purchase is declined, it’s probably for the following reasons:
- You didn’t activate your credit card
- You exceeded your credit card limit
- You made a late payment
- There’s a hold on your account (ex. you’re renting a car and the company has a “hold” on your account for a deposit)
- The retailer’s internet connections become intermittent
Step #3 – The Debit
Assuming that your credit card doesn’t get declined or the retailer’s internet connection isn’t intermittent, the purchase is added to your account.
Every time you repeat Step #1 through Step #3 your additional purchase amounts are added to your account. At the end of the month, you’ll have to pay the piper via Step #4.
Step #4 – The Bill
Every month, the FI or bank that issued your credit card will send you a bill that includes every purchase made during that month. The credit card issuer will show your balance due and the minimum amount that needs to be paid for the month. Most banks in Singapore will calculate the minimum sum at 3% of the outstanding amount or $50, whichever is higher. Be sure to check what these terms are before you sign up.
Say for example your credit limit is $5,000. If you spend $1,000, your minimum amount due would be $50 and not 3% ($30).
If you just pay the $50, you will incur a financing charge for the remaining balance of $950. Keep on paying the minimum amount due every month and your financing charge will be compounded. Continue to spend $1,000 a month while only paying the minimum amount due and you’ll surpass your credit limit in five months!
Ideally, you’ll want to pay off that bill in FULL every time by its due date and no later – otherwise you’ll have to deal with additional fees for interest on your purchases and paying late.
Step #5 – The Credit History
This is probably the most important step in how credit cards work.
Every time you pay your credit card on time, maintain a low credit card balance or even better – pay your balance in FULL each month – you’re building up your credit rating.
Having a good credit history shows FIs and banks that you’re financially responsible, which will make it easier for you in the future to borrow money major purchases such as property or a car.