What is a credit card?
A credit card is a type of payment card in which charges are made against a line of credit instead of the account holder’s cash deposits. When someone uses a credit card to make a purchase, that person’s account accrues a balance that must be paid off each month. Although failure to pay off the credit card on time could result in interest charges and late fees, credit cards can also help users build a positive credit history.
Credit is a measure of a person’s ability to pay back her debt on time, which is described in a credit history compiled by a credit bureau and expressed by a three-digit number called a credit score. The more credit a person has, the more purchases she can make using the credit because she is more trusted by lenders and banks. Frequently, credit is issued in the form of a line of credit, a stated amount that gets depleted by purchases each month and replenished by payments toward it.
A credit card is the most common way to access a line of credit. Usually issued by a bank or financial services company, credit cards allow account holders to make purchases on credit without having to put up cash at the point of sale. Instead, the charges accrue as a balance that must be paid off on a monthly billing cycle, giving the buyer more time to get the cash together. The amount of a credit card line of credit, usually called a credit limit, is determined by the card holder’s credit score and income.
When the credit card holder pays her statement balance off in full each month, she can expect her credit score to go up. She’ll be more likely to qualify for better loans at higher amounts and be approved for activities that require good credit, such as renting an apartment. Additionally, almost all credit cards come with some kind of rewards program in which account holders earn points per every dollar spent, which can be redeemed for cash back, frequent-flyer miles, or goods and services. Such rewards may even be amplified if the credit card is co-issued by a bank and a retailer, in what’s called a co-branded card: points earned may be worth more when used at the retailer who issued the card.
If the account holder fails to pay on time, the unpaid balance may start to accrue interest. Because credit cards are essentially unsecured loans — meaning that no collateral backs up the debt if the account holder defaults on what she owes — the interest rate charged to delinquent accounts is much higher than other types of loans, like mortgages. Not only will the balance and interest have to be paid off, but late payments could actually lower the account holder’s credit score.
The major financial institutions that issue credit cards are Visa, Mastercard, Discover, and American Express. When banks issue credit cards, they rely on those companies to process payments.
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Credit card example
Virtually all airlines take part in a co-branded credit card program, either issuing cards specific to their brand or as part of a larger suite of brands. Delta, for example, partners with American Express to offer frequent-flyer miles through its SkyMiles brand with a Delta SkyMiles credit card. The card gives account holders complementary perks, like early boarding on Delta flights, and extra points on purchases made with Delta, such as snacks on the plane. Although it has an annual fee of $95, Delta usually offers between 30,000 and 60,000 miles for new sign-ups, enough to make a domestic roundtrip flight.