Credit cards are financial tools that are designed to make your life easier. In fact, the cards offer you the extra buying power, convenience, emergency protection, security, and expenses management. Have you enjoyed the benefits that your cards offer? Or, do you keep spending till you are deep in debt?
Well, your cards might be just pieces of plastic that easily fit in your wallet. Even though their names are synonymous to consumption spending, they are personal loans that you can use for both consumptive and productive spending — accumulate debt or create wealth.
How Credit Cards Work
Put simply, a credit card is a financial arrangement between you and the card issuer. Using this loan facility, you may borrow money from the lending institution up to a credit limit and promise to repay them back over a certain grace period or payment-due date.
Grace period is an important concept. If you don’t pay your outstanding balance in full there will be interest charges and the grace period does not apply. There is no grace period if you do have any outstanding balance from previous month.
Whenever you pay for an item with your card, your card issuer will process the amount, the date and the place of the transaction. This will show up on your monthly billing statement indicating all transactions made, outstanding fees, the total amount owed and the payment-due date.
On the payment-due date you must pay either the full amount or partial amount of the bill. If you pay your balance in full the loan is interest free. And if you pay on time, partial amount or the minimum payment, you’ll only be charged with pre-agreed interest charge. But if you don’t pay even the minimum on time, there will be a late fee too.
Credit Card Rates, Interest Charges and Other Fees
Different financial institutions have different interest calculation methods. As interest charges can make a significant difference be sure you understand how your card issuer calculate interest charges. The following is an example of how a creditor makes an interest rate calculation for purchase transactions.
Credit card companies usually quote the APRs (Annual Percentage Rates) as the “interest rate” for using their card. But, this is not entirely true. When you do not pay the total outstanding balance, an interest charge is added on to the unpaid amount and becomes next month’s outstanding balance.
Every month, the interest rate is applied to unpaid outstanding balance. This process is often called compounding interest. The total of the compounding interest is the Effective Annual Rate (EAR), the TRUE interest rate, which is higher than the APR. They will charge you with the rate on your balance from the date of each purchase if you don’t pay the balance in full.
In addition to interest charges card issuers also charge various fixed fees. These fees include, but not limited to, annual fees, cash advance fees, late-payment fees, balance transfer fees and over-credit-limit fees.
Can You Create Wealth with Your Credit Cards?
Now that you have a better understanding on how your cards work, you’d better settle your cards’ total outstanding balance monthly. Smart users pay the total balance on the payment-due date. For consumptive spending use your cards as a payment tool — as cash or bank notes replacement — and pay only for what you can afford as if you did not have them.
Do you believe that your plastic card can help you make money? Let’s say you find a good real estate deal and the owner requires an instant down payment of $5,000. Take out cash advances from your credit cards to purchase the property. If you do it right your cash inflow from your property can cover the interest charges and other fees.