A credit card is a powerful thing. If used properly, it could help you increase your spending power, avoid interest, and improve your credit. So, how does a credit card work precisely, and what are its benefits? This and many more we’ll get to look at as we go further.
How Does a Credit Card Work?
A credit card is a revolving line of credit. In other words, it’s a loan with an open-ended lending period and a limited amount that you can borrow, otherwise known as your credit limit.
So, let’s say your credit card has a $300 credit limit. Suddenly, you have an unexpected medical expense of $100 for prescription pills. And you won’t have the money until your next paycheck, but your health can’t wait. With your credit card, you can buy the medicine now, and pay for it later. It’s like being able to get an instant limited loan. This increases your spending power, one of the key benefits of using a credit card.
However, you don’t want to use it too much.
Experts suggest keeping your balance below 30% of your credit limit. A higher balance makes you look riskier to lenders because you have less available credit. Another reason to keep your balance low is interest. Your interest rate is applied to your balance. If your balance is higher, your interest charges will be higher too. For instance, if your interest rate is 20%, the moment you spend $100 on medicine that interest rate starts calculating. But, here’s a little secret. If you pay your balance in full each month, you don’t have to pay the interest, thus making your credit card appear like an interest-free loan.
However, if you only make the minimum payment let’s say $25, you get charged 20% interest on the remaining $75. And if you pay late, you may even be charged late fees or face an interest rate increase. That’s why it’s so important to keep your balance low and if possible, pay in full at the end of each month.
Benefits of a Credit Card
Helps improve Credit score
Paying your credit card on time and in full each month looks good on your credit report and helps increase your credit score, which comes in handy when shopping for a house, car or even an apartment. How does this work? On your credit report, there is a tracker of how many times you pay on time every time you pay on time. And a record like this helps your credit.
Using a credit card can also help you better track your purchases unlike with cash, you’ll have a record of what you charge, which can help you better budget your money.
Your credit card helps protect you from theft and fraudulent activity. That’s because you won’t have to carry as much cash around, and if you notice a fraudulent charge on your card, you can dispute it.
So if you’re the honest type who is more likely to return any form of a temporary loan, using a credit card could be the best option for you. However, if you’re not good at keeping to promises or paying back loans, please keep off the credit zone, so you won’t end up denting your identity.