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2005

How Credit Cards Work

Credit cards have become a major financial industry, uniting cultures with a common form of payment and allowing purchases to be made on credit so that individuals have additional options when they’re short on cash.

Unfortunately, many people see credit cards as simply a way to spend more money than they have… this isn’t what credit cards are designed to do, and this disregard for their purpose can lead to credit problems and even bankruptcy if left unchecked.

Of course, some people end up abusing credit cards simply because they don’t fully understand how the cards work. When dealing with credit, however, a lack of understanding can end up being quite costly in the long run.

To help correct this, below you’ll find some basic information on what credit cards are, how they work, and what uses they are and aren’t intended for.

What They Are

One of the biggest questions that individuals tend to have about credit cards pertains to exactly what the cards are. Are they issued by banks, or by corporations? Are they a type of bank account, or something else entirely? These questions can seem especially confusing when you hear about the companies that offer the cards, but then see those companies’ cards being issued by local banks.

To make matters a bit more confusing (at least at first), credit cards are a little bit of all of the options. For the most part, they are issued by banks… however, the banks are given the chance to issue them by the corporations that created the cards or in some cases, the banks are actually owned by the corporation.

Once the card is issued, there is a type of bank account involved… the account that is associated with the card is actually a type of loan instead of a standard bank account, however.

How They Work

A special account known as a credit line is created by the bank, and it works as somewhat of an inverse chequing account… instead of depositing money into the account and writing cheques to decrease the available balance, the credit line balance begins at zero and with each usage the balance is increased.

This balance must then be repaid, as the usage of the card is simply a temporary loan that’s issued by the bank.

It should also be noted that there are an increasing number of debit cards and cheque cards that are being used worldwide, and that while they bear the same company logos as credit cards and are processed the same way, they are different in that they don’t use a credit line… instead, they simply draw funds from the chequing account that they are linked to as though the user had actually written a cheque.

How They Should Be Used

Great care should be exercised when using credit cards, simply because it can be so easy to get into debt with them… after all, the card will allow you to charge up to its credit limit whether you have the ability to repay the charges or not.

Instead of simply charging everything to your credit cards, you should reserve them for special purchases or for specific types of purchases.

Credit cards should be used as additional resources to get the things that you want or need, not as free money.

Make sure that when you do use your card you can afford to make the payments for the purchase… and keep in mind that the longer you keep a balance, the more interest you’ll accrue and the more expensive your purchase will become.

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