How do Credit Cards Work? Here’s an Easy-to-understand Guide

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A credit card may look like a simple rectangular piece of plastic, but it can be your most trusted friend when you need to take care of short-term financial requirements. When you look back, you can probably count the number of times when you were in need of funds but didn’t have enough cash at hand, before the advent of credit cards. Today, a single swipe from your credit card can make your life a lot easier.

In this article, let’s find out in detail how credit cards work.

What is a credit card?

A credit card is a plastic card issued by banks and other financial companies that allows you to borrow funds whenever you want. You can think of a credit card as a short-term loan from a credit card issuer. This means you can use it to buy groceries, movie tickets and other items on credit.

The underlying principle of a credit card is that you can borrow funds to purchase goods and services on the condition that you repay the original amount plus additional charges (agreed upon). You can apply for credit card and enjoy a host of super features including welcome rewards, emergency loans and interest-free cash withdrawals from ATMs.

How does a credit card work?

A whole lot of stuff goes on behind the scenes when you swipe your credit card at your local supermarket. For instance, you have to purchase your weekly groceries. You pay for them with your credit card. At this point, the credit card terminal at the supermarket interacts with your credit card issuer and checks whether your card is valid and if you have enough credit available. If your credit card issuer confirms that you have enough credit, the transaction is approved. You can now take your goods and head home.

Available credit

Every credit card holder has a certain credit limit. This is the maximum amount of credit that your credit card company extends to you. For example, if your credit limit is Rs. 80,000, you can make purchases up to this limit each month.

Whenever you make a purchase, the credit available to you decreases by that much amount. For example, if you buy a sofa at a furniture store for Rs. 20,000, the available credit for the month goes down to Rs. 60,000. You now owe your bank Rs. 20,000. And with every purchase you make, the available credit reduces. At the end of the month, you need to clear your debts to avoid penalties. One of the best features of a credit card is that once you repay the amount you owe, your credit limit goes back to the original amount. So in this example, if you repay the Rs. 20,000 you owe, your credit limit goes back to Rs. 80,000.

Credit card balance

Credit card issuers provide cardholders with a certain amount of time to repay the borrowed amount. This period is known as the grace period, and it can range anywhere between 20-25 days (or more). To avoid interest, you would need to repay the balance in full before the grace period ends. If the payment is delayed beyond the grace period, a finance charge will be added to your balance. As a result, you would have to pay an additional amount. This finance charge is based on the balance amount and the interest rate applicable to you.

The credit card interest rate is an annual rate you pay for borrowing money on your card. The interest rates can vary from one person to another and generally depends on factors such as market rates, personal credit history and the types of credit card you own. When you pay your bills on time, you are essentially accessing credit without the need to pay interest.

Conclusion

A credit card allows you to make purchases without the need to carry around bundles of cash. In addition, it will enable you to build (or rebuild) your credit history when you pay off your bills on time. This is the reason why it is a wise decision to avail a credit card today as it let’s you enjoy the lots of benefits.

Some credit card companies such as Bajaj Finserv even gives you pre-approved offers for credit cards, personal loans, home loan, business loans and a host of other financial products – which simplifies the process of availing financing and even save on time. All you have to do is, share a few basic details and check for the pre-approved offer.

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