Understand How Credit Cards Work

Not all credit cards work the same, especially in how their interest rates are calculated, how payments are applied and how fees are charged. Here is an overview of the most important things to understand about the types of credit cards whose features differ when compared to a majority of cards

Secured Credit Cards

Secured Credit Cards can be useful to establish a credit history or repair a bad credit history when the usage of the card is reported to the credit reporting agencies - Experian, TransUnion or Equifax. The credit limit on a Secured Credit Card is established by a security deposit instead of the cardholder’s credit history. Understand how Secured Credit Cards are similar, yet different, to more traditional credit cards so that you can chose the card that works best for you.

Similarities and differences with unsecured credit cards

A Secured Credit Card functions in transactions the same as a traditional, unsecured credit card. The cardholder also receives statements and is required to make payments on the purchases made using the credit line. These payments are made with funds outside of those in the security deposit which secures the credit line on the card.

The security deposit serves as an incentive for the cardholder to keep current on their card payments. It also reduces the financial risk to the lender because they have the option to recover delinquent payments from the funds in the cardholder’s security deposit which is held in a special type of savings account.

What determines a Secured Credit Card credit limit

The credit limit for a Secured Credit Card is based upon the amount of a refundable security deposit that placed into an account by the consumer. This is different than a traditional, unsecured credit card where your credit limit is usually based on your credit score and credit report.

Often the credit limit is 50% to 100% of the security deposit, though some card providers will offer credit limits of more than 100% of the security deposit as a promotional incentive. Some card issuers may allow equity in a home to be used as the homeowner’s security for a Secured Credit Card.

Look closely at the cardholder agreement before you apply for a Secured Credit Card so that you understand exactly how its credit limit will be determined.

When the security deposit may be used

If and when a cardholder does not make their regular payments on a Secured Credit Card, the card issuer can choose to use the funds held in the security deposit to cover the defaulted amounts. When this may occur and how the funds in the security deposit savings account are used can vary between cards and card issuers. Usually funds are used from the security deposit only when an account has become severely delinquent (150 days or more) or has been closed by the customer. Read the cardholder agreement very carefully to understand the specifics that you are signing up for when applying for a Secured Credit Card.

Appearing on your credit report

Secured Credit Cards are useful in establishing credit history when they are reported to Experian, TransUnion or Equifax. Make your payments on time and keep your balances low so that the account is in good standing when it is reported to the credit bureaus

If the card issuer will not disclose whether they report on usage of a Secured Credit Card, check your credit report about 3 months after you have started using the card to see if it has appeared. The reporting practices of a card issuer, and the timing of their reports to the credit bureaus in relation to when your first payment on the card is due, will affect how long it takes for a card to first appear on your credit report.

Higher fees are common

A Secured Credit Card is usually more expensive to use than a traditional, unsecured credit card. Because the card issuer is taking on greater risk issuing a card to a consumer with poor or no credit history, the service charges and fees for a Secured Credit Card are often higher than those for most unsecured credit cards. Carefully review the cardholder agreement to understand what fees and service charges may be applicable if you sign-up for a Secured Credit Card.

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Balance Transfer Cards

A Balance Transfer Card is designed to accept transfers onto it of existing balances that you have on other credit cards. The card’s lender may also provide checks that draw on the Balance Transfer Card’s credit line so that you can pay off other revolving debt accounts and consolidate that debt onto the card.

Interest rates and fees

Balances that are transferred are often covered by different fees, interest rates and terms than those applied to new purchases made on a Balance Transfer Card. Transferred balances are usually subject to transfer fees which may be lowered or waived during an introductory period. The interest rate charged on those transferred balances may also be lowered for an introductory period, after which they raise to a higher rate. This rate may also be different than that for any new purchases made on the card.

Best terms for transferred balances only

When a Balance Transfer Card is only used to consolidate existing debt, the best card is one with the lowest transfer fees and lowest interest rate during the longest introductory period, followed by the lowest interest rate after the introductory period ends. The amount that you expect to pay each month on the transferred debt and how long the introductory fees and interest rate apply will help you calculate the expected savings with a Balance Transfer Card. Make sure that a low introductory interest rate for transferred balances is not outweighed by a high percentage transfer fee that significantly adds to the debt that you are consolidating.

Best terms for new purchases also

A Balance Transfer Card may have a different and higher interest rate for new purchases than that applied to the balances transferred. Your total debt may not be paid down as fast as you expect because payments made on a card are often applied first to the balances with a lower interest rate, which is usually the transferred debt. Only when the transferred debt is paid off will payments be applied to the new purchases which have been accumulating interest at a higher rate.

The ideal Balance Transfer Card has the lowest introductory interest rate and longest introductory period for both new purchases and transferred balances. Some cards will offer the lower interest rate on new purchases for a shorter introductory period than is applied to balances transferred to it. If you can’t find a Balance Transfer Card with good terms for both consolidated debt and new purchases, consider getting two cards – a Balance Transfer Card and a Low Interest Rate card for new purchases.

Keep open the cards that you transferred balances from

Some of your FICO Score is based upon your length of credit history and the percentage of credit available to you that you carry a balance on. Both of these factors in your FICO Score can be affected by closing existing credit card accounts. Even if you have transferred the balances from these older cards to a new Balance Transfer Card, it may make sense to keep those accounts open and unused, especially if they are among the cards that you have had open the longest. This will help to both maintain a longer credit history and a higher amount of available credit, against which your current balances are compared to determine your credit utilization.

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