Credit Card Fundamentals, Debt Management, Debt Management Service, Debt Management Program, Debt Consolidation, Consumer Credit Tips   Credit Card Fundamentals, Debt Management, Debt Management Service, Debt Management Program, Debt Consolidation, Consumer Credit Tips 
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Credit Card Fundamentals

Home > Debt Management > Credit Card Fundamentals

Credit Card Fundamentals, Debt Management, Debt Management Service, Debt Management Program, Debt Consolidation, Consumer Credit Tips
Nearly everyone today carries some form of credit or charge card. Credit cards are pre-approved lines of credit for personal loans. Properly used, they offer you great freedom and flexibility in making expenditures and maintaining financial records. If you are careless or negligent, however, they can cost you dearly far more than the already high interest rate. There are several types of credit cards, including:

Travel and Entertainment Cards. These popular credit cards (American Express, Diners Club, etc.) grant you high credit limits with no interest charges. You must, however, pay the entire balance monthly (except for items such as airline tickets, which may be paid off in installments). Since there is an annual fee for cardholders, the credit is not "free," but the finance charge declines as your volume of purchases increases. If you pay a $25 annual fee and make purchases during the year of $100 per month, your true finance charge is 2 percent; if you charge only $10 a month, your annual finance charge is 20 percent.

Since you are required to pay the outstanding balance every month, T&E cards require careful record-keeping. Otherwise, you may find you have charged more in a month than you can pay. On the other hand, since you receive a copy of the charge record each time the card is used, it is relatively easy to keep track of your expenditures.

Bank Cards. The two most popular cards, Visa and MasterCard, issued by participating banks, encourage installment payments and charge interest rates typically between 18 and 23 percent, depending on state laws. They can be used for a wide variety of purchases, but they involve substantial risks if you misuse them.

Most bank cards permit you to pay the entire monthly balance or a portion of the outstanding balance usually a minimum fee such as $20 or a percentage of the balance, whichever is greater. The interest, typically 1 1/2 percent monthly, is calculated on the balance remaining after your payment. The balance increases both by the amount of new purchases in the next month and the interest charge. Paying only the minimum due means that the interest is compounded on the next month's statement.

For example, if you have an outstanding balance of $100 and you pay the minimum due of $20, your new balance will be $80 plus $1.20 (1-1/2 percent of $80). Suppose you charge an additional $100 worth of purchases during the next month. Your statement will show a balance of $181.20. If you only pay $20 the second month, the first month's interest is included in the balance on which the new interest is calculated:
$181.20 - $20 = $161.20
$161.20 x 1-1/2% = $2.42 (finance charge)
$161.20 + $2.42 = $163.62 (new balance)

You now have been charged interest on the previous month's interest as well as on your purchases. In addition, you have increased your debt by 63.62 percent in one month! If you continue to pay only the minimum balance due, you may pyramid yourself into an unmanageable debt level. In addition, you will still be paying for your first month's purchases five months later.

To prevent bank cards from being a source of financial trouble, you normally should charge only what you can afford to pay in any given month, and pay the entire balance due at the end of the month. If you make a large purchase or use the bank card for vacation expenses and have to make installment payments, you should consider discontinuing use of the card until you have paid off the balance.

Retail Cards. Department stores and some gasoline marketers issue credit cards good only at their own establishments. In general, these cards are similar to bank cards and often carry the same interest charges. You should use the same principles in using these cards: Charge only what you can afford to pay off in a month, pay the full balance due if possible, or discontinue use of the card until you can pay off the balance using installment payments.

Department stores may charge different amounts of interest depending on the size of the purchase or the outstanding balance. In addition, they may calculate the interest on the average daily balance of the account rather than the balance at the end of the month. For example, one store reports its policies this way:

The FINANCE CHARGE is computed by applying to the AVERAGE DAILY BALANCE monthly periodic rate of 1.60 percent on amounts up to $3,000 and 1.00 percent on amounts in excess of $3,000, which are annual percentage rates of 19.20 percent and 12.00 percent respectively.

If you need to purchase goods up to $3,000 in value, you would be better off seeking a personal loan from a bank or credit union, which probably would carry a lower rate than 19.20 percent, unless you can pay off the entire amount at once.

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