Debit versus credit: Part 2
What is a credit card and how does it work?
Have you ever wondered what the difference is between a credit and debit card? If yes, you are not alone. In the previous article in this series, debit cards were discussed at length including their purpose and what happens when they are used. This article will focus on credit cards and address the following questions: what is a credit card, and what happens when I use my credit card?
What is a Credit Card?
Credit cards are an open-ended and unsecured loan that you will have to pay back. You can open a credit card from your local financial institution, department stores, or directly from credit card issuers. Because credit cards are revolving accounts, you can carry a balance if you choose not to pay your balance in full each month. Credit cards are not tied to an account at a local financial institution and you can incur interest and fees on any unpaid balances. Credit cards have a logo and can help build credit if managed appropriately. If you are trying to build your credit score, try not to charge more than 20-30 percent of your approved limit and pay your bills on time.
What happens when I use my Credit Card?
- The funds to pay for the purchase will come directly from the card issuer. Each credit card has an approved maximum limit that you can use to pay for goods and services. This limit has been granted to you by the card issuer when you signed the credit card agreement.
- When making a purchase using a credit card, you will always select credit and be asked to sign your name to authorize the payment (A Personal Identification Number may need to be entered. This will depend on upon the card reader). It is important to review all communications from your card issuer so you understand the policies and fees associated with the use of this card.
- Once the transaction takes place, the issuer is notified and your approved limit decreases immediately. Transactions may not show up immediately on your credit card statement until it has cleared.
- Charges will apply (interest) if you carry a balance or your card offers no grace period and you incur interest charges. Fees and penalties can be imposed. It is important to read the credit card agreement.
- The local retailer may pay more in transaction fees (i.e. fees for accepting certain credit cards) when you use a credit card instead of a debit card.
- The liability for loss in instances of identity theft when using a credit card is covered by the Truth in Lending Act. There is no liability for loss if reported in two business days; after two business days, your liability for loss is only up to $50.
Tips to consider:
- Some credit cards may allow you to make purchases that exceed your approved limit, for a fee. Be sure to read and understand all terms and conditions in your cardholder agreement.
- Some credit cards offer “no interest” or “low interest” introductory offers. Make note of when these offers end, and what your new interest rate will be. Be sure to read and understand all terms and conditions in your cardholder agreement.
Michigan State University Extension offers financial literacy and homeownership workshops throughout the year to help you become financially healthy. For more information about classes in your area, please visit either the MSU Extension events page or MI Money Health website. Additionally, you can take the Financial Health Survey at MI Money Health to access if you’re financially healthy and discover more ways you can improve your financial health.