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The inner workings of the credit card processing system may not mean so much to any individual cardholder-to you-directly. But a basic understanding of the mechanics should give you some idea of how impersonal the whole system is.
Card issuers (let alone card processors) don't really care who you are or what your story is. All they care about is that you keep the money flowing through the system-and you do that by paying your bills on time. Period.
With travel and entertainment cards that do not allow you to run up an outstanding balance, a good borrower pays the full amount of what he or she charges each month by the assigned due date.
If you loaned your brother-in-law a thousand dollars, under the agreement that he would pay you back $50 a month for 20 months, you’d be upset if he didn’t pay you one month. You’d be really upset if he didn’t pay you for two months. In fact, it might cause all kinds of family disharmony.
Professional money lenders feel pretty much the same way, aside from the family strife.
If you don’t pay your credit card bill on time one month, you’ll get smacked with a late fee and possibly other penalties.
You also may hurt your credit score—particularly if you get two months behind in payments.
In some cases, you aren’t just late in making payments. You’re not making payments at all. Then, the loan is considered in default—and your creditor likely will send it to a collection agency to try and get you to make good on your debt.
Once a creditor completely gives up getting repaid by you, the company writes off your debt on its taxes, and your account is considered a charge-off.
We’ll consider these black marks in greater detail later. For now, it’s enough to say that lenders share information about their customers with other lenders to help reduce the risk of future defaults and charge-offs.
Most credit card issuers prefer to lend money to someone who has demonstrated a history of paying his or her bills on time. On-time payments make the complex system run a little more smoothly.
If you've got reasonably good credit, odds are you receive credit card offers in the mail all the time. Some of those offers may sound pretty tempting, too-with high credit limits and low interest rates.
But before you fill out any application, you'll want to read the fine print-and shop around.
Although the government regulates the interest rates and other financial aspects of credit cards, the marketplace is incredibly diverse. Some cards offer cash back or frequent-flier miles based on your spending-but penalize you steeply for making a late payment. Others are more generous with grace periods-but charge a lot if you spend over your credit limit. Some cards make it easy to get cash advances-but charge you a higher interest rate than on ordinary charges.
As a smart consumer, you need weigh the pros and cons of each credit card you consider. And, before you do that, you need to know what the pros and cons are.
Using a credit card is a simple form of borrowing. And anyone who borrows money should know a few things about himself or herself before signing any agreements.
You need to consider your life-style and payment style. Are you an impulsive shopper? Are you a bargain hunter? Are you frugal? Spendy? Do you pay your bills on time? Are you not so organized?
There are no right answers to any of these questions. The point is that, as we consider the mechanics of different kinds of credit cards, you should keep in mind what kind of credit user you are. This influences the kind of card you should use.
If you pay your bill in full every month, the interest rate is not going to be as important as other card features, like frequent-flier miles or no annual fee. But if there’s even a remote chance that you might run a balance, you’ll want to focus on finding a card with a low APR.
Many people choose a credit card based on its advertised interest rate. (This rate is usually referred to as the annual percentage rate or "APR.") But the advertised rate is by no means everything you need to know to avoid an unpleasant surprise later.
Actually, a credit card can come with several different interest rates. Before you apply for a card, you'll want to learn the rates it charges for:
purchases;
cash advances; and
balance transfers.
Periodic Rate
Because “APR” is the abbreviation for annual percentage rate, and because credit card issuers send out their bills monthly, they do not use the APR to calculate the finance charges you owe in a given billing cycle.
Instead, they use what’s called the periodic rate. This is the APR divided by 12 (as in 12 months). So if your card has an APR of 12 percent, the periodic rate would be 1 percent.
That explains why you’ll see periodic rate for new charges on your credit card bills, along with the APR for your outstanding balance.
If you pay your bill in full each month, on time, you can avoid being charged interest. The time during which you can enjoy the use of the issuer's money interest-free is known as the grace period.
Most credit card issuers describe this in a rather complicated way. They say that the grace period extends for a certain number of days after your credit card statement date. (The statement date is the date on which the bill was prepared by the card issuer, not the date on which you receive it. You may receive it as long as two weeks after the statement date.)
To make matters a bit more complicated, different credit card issuers calculate finance charges in different ways. Some card companies give you a stretch during which no interest is charged for your new purchases; others start the finance charge meter running the minute you make a purchase.
It all comes down to whether or not the company includes new purchases in your outstanding balance, which is the amount on which finance charges are computed.
Credit card companies have to provide certain information in any offer that they make to you, under the federal Truth in Lending Act (TILA).
You can find this information printed in what's known as the "Schumer box" (after the U.S. Senator from New York who drafted the bill), which is required under TILA.
This box will appear on the back of the letter offering you credit, or on another sheet of paper enclosed in the same envelope.
Some retail stores and direct mail companies will push hard for you to apply for what they call a "credit card" to buy their products. But be warned: These credit cards sometimes aren't.
The January 2000 Mississippi federal court decision Willie and Emma Oliver v. Bank One, N.A. dealt with one such scheme.
The Olivers bought a television home satellite system from a door-to-door salesman. The purchase was financed by the issuance of a "credit card" by Bank One in May 1995.
Bank One furnished disclosures pursuant to the TILA, as though the credit transaction was an opened-end or revolving credit facility...what most people think of as a credit card. But there were some differences. The limit on the card was almost exactly the purchase price; and no business other than the satellite company would accept the card.
The Olivers didn't like the satellite system and eventually stopped making payments on the card by which they'd bought it. As a result, Bank One posted a negative item on their credit report. The Olivers sued Bank One.
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