Financial Tips | Debt Management

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1/12/09

How Does a Credit Card Work?

Credit can be a very powerful financial tool. Having good credit can help you get loans, can lower the interest rate that you pay for such loans, and get help you get favorable loan terms. Therefore, having good credit will help you get loans and will help you save money. On the other hand, should you have bad credit the exact opposite will happen. You will most likely be denied for loans. Additionally, should you get a loan, the interest rate will be very high and the loan terms will not be favorable to you. As such, you should strive to obtain and maintain a good credit score. However, in order to obtain a good credit score you have to known how credit works.

You should always think of credit as a loan. If you think of credit as a loan, it will put you in the proper mindset when you use your credit cards. In other words, you will not forget that using the credit card means that you have to pay back the amount that you charge. If you think of a credit card as a second bank account, you are going to get into a lot of financial trouble. Basically, you will not keep track of your charges, and you will not be responsible with your credit card use.

How credit works is very simple. When you obtain a credit card you are given a particular credit limit. This credit limit is the total amount of money that you can borrow on your credit card. You can utilize your entire credit limit at once or you can use your credit card for a bunch of purchases until the total amount of the purchases equal the credit limit.

Basically, when your credit card is swiped by the store, restaurant, or other location from which you purchased something, the credit card company pays the store, restaurant, or other business the amount that you owe. In exchange for this service, you are able to defer your payment of such a bill until a later date. In addition, credit card companies allow you to pay over time instead of in one single lump. In exchange for allowing you to pay this debt over time, the credit card company charges you an interest rate. Your credit card agreement will dictate how often the interest rate is charged on your outstanding balance.

In a nutshell, a credit card purchase is a loan from your credit card company. The most amount of money you can borrow is dictated by your credit limit. You have to pay back this loan either at one time or over time in the form of monthly payments. Should you choose to pay over time, the credit card company will charge you an interest rate on your outstanding balance. This is how credit cards work.

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