Benefits of using a credit card
2 out of three Americans own a credit card and use it regularly. Most of us are aware about the benefits of credit card usage. Some however are held back either because of lack of knowledge of how credit cards work and in some cases the social stigma associated with debt and using money that does not belong to oneself.
There are no shortage of stories where people can have been crushed under a mountain of debt due to improper credit card usage. However, when credit cards are used knowledgeably and with prudence, they can be a powerful financial tool to save and grow your wealth.
What is a credit card?
A credit card is a financial instrument (typically a plastic or metal rectangular card) that allows the cardholder to pay for his purchases by borrowing from a pre-approved credit limit determined basis his income and credit reliability.
How does a credit card work?
Every credit card has a pre-approved credit limit. Once the card holder swipes the card either at an online market place or at a merchant’s outlet, the details are immediately sent to the credit card issuing company. The credit card company validates the details and either rejects or approves the transaction. Once the transaction is approved, the amount is then deducted from the credit card holder’s pre-approved amount. The merchant pays a nominal fee called the Merchant Discount Rate(MDR) for this, since it has enabled him to make a sale.
At the end of the billing period, all such transactions are accumulated and the cardholder has to pay this amount to the credit card company usually within 45-60 days, depending on his grace period. Failure to pay this amount will result in high interest charges, sometimes as high as 45% per annum.
Benefits of using a credit card
1. Cash back and bonuses
Several cards offer a one time joining bonus, or a bonus on achieving certain milestones. In addition to this they also offer a cash back or reward points. These can be redeemed for anything of ones choice. The cash backs can be as high as 5%.
Paying with a credit card protects you from unauthorized usage and fraud. When your debit card is lost and fraudulently swiped, the money is instantly debited from your savings account. However, when a credit card is fraudulently swiped, you can report the transaction to the credit card company and the transaction would be reversed.
3. Credit building
If you are seeking to build or improve your credit score, using a credit card responsibly is the best and fastest way to do so. Debit card usage does not get tracked anywhere, and it does not add to your credit score. A high credit score can help you be eligible for better loan terms.
4. Interest Free debt
A credit card when used prudently is effectively a debt at zero interest rate. No other financial instrument can provide a debt at zero interest rate. This is one of the best financial instrument that exists. However, when used rashly credit card interest on late repayment can kill your financial independence and cripple your dreams.
5. Universal acceptance
There are certain purchases which are difficult to do with a debit card. Most hotels and car rental companies prefer to charge a credit card instead of a debit card, since the final amount of the transaction is not known until the transaction is complete. Also, when you’re traveling in a foreign country, merchants won’t always accept your debit card—even when it has a major bank logo on it.