What is it?
A credit card is issued by a lender and permits the user to make purchases on credit with payment due at a later date. When you use a credit card, you are actually borrowing money from a revolving line of credit. The maximum total charges you are authorized to make (your credit limit) is set by the lender when you apply for the card and may be periodically adjusted. When you make a purchase using the card, the lender pays cash directly to the merchant. Thereafter, the lender bills you monthly for the amount charged, plus interest. You can pay the entire outstanding balance immediately or make payments until the balance is repaid. As you pay down the balance, you can charge it back up to your credit limit; hence the term revolving credit line.
You can also use most credit cards to obtain cash when you need it. This is referred to as a cash advance. Most credit card lenders offer a cash advance feature that allows you to obtain cash by presenting your credit card to a bank, credit union, or other financial institution, or by using the credit card at an ATM. The credit card lender repays the bank and bills you for the amount of the advance plus interest.
Who can use credit cards?
A credit card can be used by its owner or authorized user. Cards are generally issued individually or jointly. They can also be issued to businesses. The name of the owner or authorized user is embossed on the front of the card.
What are the advantages of credit card borrowing?
Nearly universal acceptance
Credit cards are accepted almost everywhere today, including supermarkets, doctor’s offices, and retail stores. Generally, merchants will accept all, or at least several, of the most commonly used cards. Accordingly, if you carry one or more major credit cards, you should have little trouble finding a merchant or bank to honor them.
Very convenient to use
Credit card borrowing is very convenient. Credit cards can be easily carried in a wallet or pocketbook. As mentioned, credit cards are accepted nearly everywhere. Generally, the agreement with the lender is completed before you get the card. If you wish to make a purchase, you simply present the card to the merchant. The merchant can usually obtain electronic authorization (not necessary for smaller purchases) from your lender within a few seconds. If the purchase is made in person, you merely sign the credit card receipt. Mail order purchases, travel reservations, and other such transactions can be completed over the phone by using a credit card. Indeed, modern technology has made credit card transactions nearly as quick and convenient as cash transactions.
More secure than cash
Credit cards offer more security than cash. If your wallet or purse is stolen, your credit cards might be put to fraudulent use. However, there are some built-in protections provided by the credit card industry to minimize risk. You are asked to place your signature on a textured strip on the back of your card. Ideally, merchants will check the signature on the card to see if it matches the signature on the credit card receipt. Cards issued by your personal bank or credit union may include your photograph. Also, merchants can obtain electronic authorization for purchases. If the card has been lost or stolen, and you have notified the lender, authorization will be declined. Finally, in the case of lost or stolen cards, your liability for unauthorized purchases does not exceed $50, provided that you have notified the lender in a timely manner. None of these protections are available with cash.
Can provide an excellent source of short-term, no-interest funding
Properly managed, credit cards give you the opportunity to capitalize on short-term, no-interest loans every month. Finance your groceries, gasoline, dry cleaning, entertainment, and other regular monthly expenses using your credit card. When the bill arrives, pay the balance off in full. You will incur no interest charges, and your money will have continued to earn interest in your bank account for an additional 30 days. If you select a card that has no annual fee, the cost of borrowing will be zero.
What are the tradeoffs of using credit cards?
Generally, the cost of credit card borrowing is high
If you carry a balance, credit card borrowing can be expensive. On average, credit card interest rates are steep. Many cards offer low introductory rates for the first six months but raise the rate thereafter. Even many of the so-called low-interest credit cards charge double-digit interest rates at a time when your bank offers only 3 percent on your savings account. Many cards charge as much as 21 percent. Many charge an additional annual fee, plus service charges for cash advances.
It is easy to get in over your head
Credit card companies may offer consumers more credit than they can afford to repay. Many companies offer liberal credit lines and raise them automatically or upon request. Although interest rates are high, credit cards remain attractive to many borrowers because of their low required minimum monthly payment. Borrowers thus feel secure charging large amounts on their cards because they know they can make at least the minimum payment.
The problem is that the minimum monthly payment is what makes credit cards so burdensome for most borrowers. If you make the minimum monthly payments on a balance of $1,000 with an interest rate of 18 percent, you could be making payments for almost 10 years (providing no new charges are incurred during that time). Many borrowers faced with exorbitant balances become hopeless and unrealistic about their ability to get out of debt. Many take cash advances from one card to make payments on another.
Are there tax implications involved with credit card borrowing?
Interest on credit card debt is not deductible.
Conclusion
Credit cards offer a convenient and widely accepted method of borrowing, providing benefits such as security, short-term interest-free funding, and rewards programs. They can be an excellent financial tool when managed responsibly, allowing users to take advantage of credit while maintaining financial flexibility. However, the ease of access to credit, high-interest rates, and the risk of accumulating excessive debt make it essential to use credit cards wisely.
To maximize the advantages of credit card borrowing, cardholders should aim to pay off balances in full each month, avoid unnecessary fees, and take advantage of available perks without overextending their finances. Conversely, failing to manage credit wisely can lead to long-term financial strain, increased costs, and even insolvency.
Ultimately, credit cards should be used strategically, not as a means of long-term borrowing but as a tool to enhance financial well-being. By understanding the benefits and trade-offs, consumers can make informed decisions that support their financial health and future stability.
Scarlet Oak Financial Services can be reached at 800.871.1219 or contact us here. Click here to sign up for our weekly newsletter with the latest economic news.
Source:
Broadridge Investor Communication Solutions, Inc. prepared this material for use by Scarlet Oak Financial Services.
Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on individual circumstances. Scarlet Oak Financial Services provide these materials for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
