Credit cards may seem like a regular part of everyday life but are in effect a very sophisticated financial instrument. To help understand how to use credit cards better it is a good idea to understand how they work.
The first thing that someone should understand about a credit card is the payment mechanism. A person simply needs to enter a set of numbers (or give over a card with a set of numbers) and they can spend money at most shops, with many service providers and over the internet. Credit cards have a level of acceptance that is surpassed only by cash.
This is partly due to the fact that credit card providers have managed to get a high level of technology that means that the credit card provider is easy for the shop owner to communicate with but that also helps to prevent fraud. However the main reason is that the shop owner trusts the credit card issuer and not the person. The credit card issuer has convinced the shop owner that they will get paid if the card is accepted. This is unlike a cheque which can take days before the money appears in the bank account.
After this the money goes into an account that is always changing. As there are no standard repayments, and there are constantly changing purchases, then the balance moves around far more frequently than a standard bank loan or mortgage. This means that the account needs to be constantly monitored by the provider, firstly so that the regular monthly statements are sent out and the minimum payments are calculated, but also so that interest can be added on and credit limits can be monitored. Part of the reason that credit cards are so expensive is that they are far harder to keep track with compared to most other forms of credit due to their convenience.
The consumer has the choice of how much they wish to pay off between a minimum payment and the whole amount. The minimum payment is calculated so that the credit card provider knows that the credit card user is still able to service the card and is aware enough of it so that the card provider should not be concerned. Not making regular repayments is the most potent warning signal that the borrower may be in trouble. Unlike many other forms of credit the repayments are flexible and a very large proportion of credit card users pay their credit cards every month.
