Meaning of Credit

card A credit card is a system of payment named after the small plastic card issued to users of the system. A credit card is different from a debit card in that it does not remove money from the user's account after every transaction. In the case of credit cards, the issuer lends money to the consumer (or the user). It is also different from a charge card (though this name is sometimes used by the public to describe credit cards), which requires the balance to be paid in full each month. In contrast, a credit card allows the consumer to 'revolve' their balance, at the cost of having interest charged. Most credit cards are the same shape and size, as specified by the ISO 7810 standard

How credit

cards work Have you ever stood behind someone in line at the store and watched him shuffle through a stack of what must be at least 10 credit cards? Consumers with this many cards are still in the minority, but experts say that the majority of U.S. citizens have at least one credit card -- and usually two or three. It's true that credit cards have become important sources of identification -- if you want to rent a car, for example, you really need a major credit card. And used wisely, a credit card can provide convenience and allow you to make purchases with nearly a month to pay for them before finance charges kick in. That sounds good, in theory. But in reality, many consumers are unable to take advantage of these benefits because they carry a balance on their credit card from month to month, paying finance charges that can go up to a whopping 23 percent. Many find it hard to resist using the old "plastic" for impulse purchases or buying things they really can't afford. The numbers are striking: In 1999, American consumers charged about $1.2 trillion on their general-purpose credit cards. In this edition of we'll look at the credit card -- how it works both financially and technically, and we'll offer tips on how to shop for a credit card. (Experts say this should be a project on the scale of shopping for a car loan or mortgage!) We'll also describe the different credit-card plans available, talk about your credit history and how that might affect your card options, and discuss how to avoid credit-card fraud -- both online and in the real world.

The Stripe

The stripe on the back of a credit card is a magnetic stripe, often called a magstripe. The magstripe is made up of tiny iron-based magnetic particles in a plastic-like film. Each particle is really a tiny bar magnet about 20-millionths of an inch long. The magstripe can be "written" because the tiny bar magnets can be magnetized in either a north or south pole direction. The magstripe on the back of the card is very similar to a piece of cassette tape (see How Cassette Tapes Work for details). A magstripe reader (you may have seen one hooked to someone's PC at a bazaar or fair) can understand the information on the three-track stripe. If the ATM isn't accepting your card, your problem is probably either: A dirty or scratched magstripe An erased magstripe (The most common causes for erased magstripes are exposure to magnets, like the small ones used to hold notes and pictures on the refrigerator, and exposure to a store's electronic article surveillance (EAS) tag demagnetizer.) Information on the StripeThere are three tracks on the magstripe. Each track is about one-tenth of an inch wide. The ISO/IEC standard 7811, which is used by banks, specifies: Track one is 210 bits per inch (bpi), and holds 79 6-bit plus parity bit read-only characters. Track two is 75 bpi, and holds 40 4-bit plus parity bit characters. Track three is 210 bpi, and holds 107 4-bit plus parity bit characters. Your credit card typically uses only tracks one and two. Track three is a read/write track (which includes an encrypted PIN, country code, currency units and amount authorized), but its usage is not standardized among banks.

Financial Jargo

Before we get into shopping for a card, let's go over some important terms you'll encounter in credit-card brochures or discussions with potential lenders: Annual fee - A flat, yearly charge similar to a membership fee Many companies offer "no annual fee" cards today, and lenders who do charge annual fees are often willing to waive them to keep your business. Finance charge - The dollar amount you pay to use credit Besides interest costs, this may include other charges such as cash-advance fees, which are charged against your card when you borrow cash from the lender. (You generally pay higher interest on cash advances than on purchases -- check your latest bill to find out what you're paying for this service!) Grace period - A time period, usually about 25 days, during which you can pay your credit-card bill without paying a finance charge Under almost all credit-card plans, the grace period only applies if you pay your balance in full each month. It does not apply if you carry a balance forward. Also, the grace period does not apply to cash advances. Annual percentage rate (APR) - The yearly percentage rate of the finance charge Interest rates on credit-card plans change over time. Some of these adjustments are tied to changes in other interest rates, such as the prime rate or the Treasury Bill rate, and are called variable-rate plans. Others are not explicitly tied to changes in other interest rates and are called fixed-rate plans. Fixed rate - A fixed annual percentage rate of the finance charge Variable rate - Prime rate (which varies) plus an added percentage (For example, your rate may be PR + 3.9 percent.) Introductory rate - A temporary, lower APR that usually lasts for about six months before converting to the normal fixed or variable rate (This is a hot topic -- more about it later.) Shopping AroundExperts say that if you're smart, you'll do the same kind of comparison shopping for a credit card that you do when you're looking for a mortgage or a car loan. This is a good idea because the choices you make can save you money. The process is not a simple one -- here are some tips that should help you get started: 1. Do some research - There are plenty of places, both online and offline, where you can read about credit-card offerings and even get credit-card ratings, but since rates and plans change so often, it's a good idea to call the institutions you're interested in to confirm the information and to see if there are other plans that might work for you. 2. Make a list - Make a list of credit-card features that fit your financial needs and rank the features according to how you plan to use the card and pay your monthly bill. 3. Review the plans - Review all of the information you've gathered on different plans. Pay special attention to the APR -- you want a low rate, but not necessarily the lowest. This is because, depending on your lifestyle and payment habits, you might benefit more from a card that offers cash rebates, discounts or frequent-flier miles. 4. Check out credit unions - Look into the possibility of joining a credit union; they are non-profit, have lower overhead and so charge lower interest rates (an average of 13.14 percent currently on a fixed-rate card). Credit unions are newer to the credit industry so they are eager to generate credit-card loans. However, you'll probably be required to open a share account or savings account to join. 5. Compare plans - If you already have a credit card, be sure that you're making a good move before you swap cards. If you are a current cardholder and have a good credit rating, see if the institution that issued your card will lower your current rate. Don't be afraid to negotiate!

Card Types

There are basically three types of credit cards: Bank cards, issued by banks (for example, Visa, MasterCard and Discover Card) Travel and entertainment (T&E) cards, such as American Express and Diners Club House cards that are good only in one chain of stores (Sears is the biggest one of these, followed by the oil companies, phone companies and local department stores.) T&E cards and national house cards have the same terms and conditions wherever you apply. You may also be familiar with what is known as an affinity card. This card -- typically a MasterCard or Visa -- carries the logo of an organization in addition to the lender's emblem. Usually, these cardholders derive some benefit from using the card -- maybe frequent-flyer miles or points toward merchandise. The organization solicits its members to get cards, with the idea of keeping the group's name in front of the cardholder. In addition to establishing brand loyalty, the organization receives some financial incentive (a fraction of the annual fee or the finance charge, or some small amount per transaction or a combination of these) from the credit-card company. No one card is right for everyone. Basically, the right card for you is one that's accepted where you shop and charges you the smallest amount of money for the services you use. Almost any U.S. business or establishment that takes MasterCard also takes Visa, and vice versa. So if you only spend money in the United States, you probably don't need both

Variable vs. Fixed Rate

Whether the credit-card plan uses a variable or fixed rate in charging interest can have a significant effect on what you pay to use your card. Variable RateCredit-card companies that issue variable-rate plans use indexes such as the prime rate, the one-, three- or six-month Treasury Bill rate or the federal funds or Federal Reserve discount rate. (Most of these indexes can be found in the money or business sections of major newspapers. See the list of links at the end of this article.) Once the interest rate corresponding to the index has been identified, the credit-card issuer then adds a number of percentage points -- called the margin -- to this index rate to come up with the rate the consumer will be charged. In some cases, the issuer might choose to use another formula to determine the rate to be charged. These issuers multiply the index or index plus the margin by another number, the "multiple," to calculate the rate. Fixed RateTake a good look at fixed-rate plans. They may be a couple of percentage points higher than a variable rate, but you will have the advantage of knowing what your interest rate will be. Variable rates are just that -- they change -- and can increase (usually the case) or decrease your finance charges. If your rate is fixed, the Truth in Lending Act requires the lender to provide at least 15 days notice before raising the rate. In some states, there are laws that require more notice. Some financial analysts argue that because a fixed rate can be increased with only a 15-day notice, this plan is not that different from a variable-rate plan, which is subject to change at any time. They advise looking closely at both plans. If you do choose a variable-rate card, check to see if there are caps on how high or how low your interest rate can go. If the lowest variable rate possible on your card, for example, is 15.9 percent, and rates are trending downward, you may want to switch your card to another lender. Few experts will argue with the fact that a low interest rate is a good thing. To illustrate the importance of a low interest rate, let's look at a simple example of how much your annual savings might be if you switch to a credit-card plan with a lower interest rate and no annual fee. In our example, the average monthly balance carried forward equals $2,500, which is about the national average for consumers with credit-card debt. Total annual savings in this example -- $120. Regardless of which plan you choose, you're going to be making payments. Let's take a look at how this is done. Paying the BillSome credit cards, such as American Express, require you to pay off all of your charges each month. As a benefit, they usually have no finance charge, and sometimes no maximum limit. Most cards, including Visa, MasterCard, Discover and Optima, offer what is known as revolving credit.

Adjusted balance

This system, which consumer experts say favors the cardholder, takes the balance from your previous statement, adds new charges, subtracts the payment you made and then multiplies this number by the monthly interest rate. Average daily balance -- This method, which is a pretty even-handed one and the most commonly used, works like this: The company tracks your balance day-by-day, adding charges and subtracting payments as they occur. At the end of the period, they compute the average of these daily totals and then multiply this number by the monthly interest rate to find your finance charge. Previous balance -- This method generally favors the card issuer, according to consumer experts. The issuer multiplies your previous statement's balance by the monthly interest rate to find the new finance charge. This means you're still being charged interest on your balance a whole period after you've paid it down! What you pay will vary depending on your balance, the interest rate and the way your finance charge is calculated. Here's an example that shows how much difference the interest rate can make in what you actually end up paying: High-rate card: Suppose you charge $1,000 on a 23.99-percent credit card. After that, you make no further charges and pay only the minimum each month. The payment will start at $51 and slowly work its way down to $10. You'll make 77 payments over the next six years and five months. By then, you will have paid $573.59 in interest for your credit privilege. Low-rate card: If you charge that same $1,000 on a 9.9-percent fixed-rate card, the minimum monthly payment will start at $50.41 and go down to $10. You'll make 17 fewer payments, finishing in six years and paying $176 in interest. This saves you almost $400! Late fees and over-the-limit fees are a couple of newer charges that are used by pretty much all credit-card issuers now. And increasingly, issuers are drastically raising interest rates (to as high as 23.99 percent) after a set number of late payments (read the fine print and make sure you know whether the payment is considered posted on its postmarked date or on the date the bank or credit-card company gets it posted!). Unfortunately, once you have a couple of late payments, the credit-card company can charge you the inflated interest rate for the remaining life of the account. Try to avoid this -- all credit-card companies report your payment record to credit-reporting agencies and even a few late payments could cause you problems when you try to buy a car or a house. And as most of us know, even credit-card companies make mistakes. The next section discusses how to make sure you're paying only what you owe.

Qualifying for a Card

There's no way to know if you'll qualify for a credit card without doing some research. Some of the basic things that lenders look for include: Good payment record - If you pay your bills on time, you'll score major points with lenders. If you have a lot of late payments, this can hurt your chances of getting a card, and, if the lender decides to issue you a card, it's probably going to have a higher interest rate. Control of debt load - Lenders generally want to see that you are a good credit risk and that you aren't living beyond your means. Experts say that non-mortgage credit payments each month should not exceed more than 10 percent to 15 percent of your take-home pay. Signs of stability, responsibility - Lenders perceive things such as longevity in your home and job (at least two years) as signs of stability. Having a respected profession doesn't hurt either. Lack of credit inquiries - This one is a little strange. Whenever you apply for a credit card, the lender pulls your credit report from one or more of the major bureaus as part of the approval process. Each time a report is pulled, it's marked as an inquiry and stays on your credit bureau report for two years. Lenders perceive several inquiries on your report as indications that you're scrambling for loans and may consider you a poor credit risk. So, in order to beat this system, don't allow every credit-card issuer you speak with to pull your report. Lack of available or unused credit - Did you know that having credit cards that you don't use -- and have a zero balance on -- can hurt your credit? The rationale here, experts say, is that if you have all this available credit lying around, you could run it up at any time (even if you never have). Get rid of the cards you don't use. Be sure to ask the credit-reporting bureaus to remove the discarded cards from your report, noting that you -- not the creditor -- closed the account. Once you qualify for a card, or several cards, there's always the chance that you'll end up spending more than you've got. A pretty good chance, actually. The next section discusses what you can do if you find yourself in credit-card debt.

Getting Rid of Debt

If your credit-card balance has crept up to uncomfortable levels, you're not alone. Millions of Americans have learned -- the hard way -- how easy it is to use and abuse their credit cards and how difficult it can be to pay them off. The Debt Counselors of America and the National Consumer Law Center offer these credit-card debt elimination tips: Always be aware of all of the fees that may be associated with your credit card. (That means not tossing out the fine-print leaflets that come in your bill periodically!) Know the annual fees, current interest rates, finance charges, cash-advance fees and any other fees tied in with your card. This knowledge can help you make better decisions on how to manage your card. Cash advances can be trouble! You should only get cash advances when it is absolutely necessary. Higher interest rates (than you're paying for card purchases) are usually charged, and most banks also charge a service fee related to how much cash you're withdrawing. (The same applies to those handy, personalized "checks" the credit-card company sends you!) Always be on the look-out for cards that offer lower interest rates. Transferring balances from one card to another to take advantage of low introductory rates is a common practice among U.S. cardholders. Low introductory rates can be very helpful in your quest to become free of credit-card debt. You should look for credit cards that offer a low intro rate (usually for six months), and transfer the balance from your previous credit card to that credit card. Before you take this step, however, make sure that, after the intro rate has expired, the new card offers the same (or lower) interest rate as your current card. Experts say that making minimum payments is one of the most common mistakes consumers make. You will save lots of money on interest and get to debt-free goals sooner if you pay more than what is required each month. It's true that it's really easy to fall into the credit-card trap, and not so easy to get out. But don't give up -- there are non-profit centers across the country that will provide counseling to you and will even (at no or low charge) contact your credit-card company and try to get your rate lowered or a different payment plan worked out.