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Credit Card Terms – and how credit cards work

To help you understand how credit cards work, here are some credit card terms you’ll hear:

Honeymoon Rate
Also called a teaser rate or introductory rate - this is the initial (and tempting low) interest rate charged for the first 6 months or so that you own the card. This is how creditors tempt you to open an account with them, and also tempt you to transfer your current credit card debt onto this card. 

If you ARE tempted – that’s fine. BUT look at the standard and penalty interest rates on the card. If these are higher than your current card (or other ones you’re looking at) then it may not be the best choice for you, if there is a chance you’ll accumulate a debt on the card as you’ll just end up paying more interest in the long run.

You CAN take advantage of a low start up rate on a credit card for paying off your current debts. Transfer your debt (or some of it) to this new card, which will reduce the interest repayments on what you owe – but here’s the trick. Make sure you pay off as much of this debt as you can (preferably all of it) before the honeymoon period is over.

For example, if your current debt is $6,000 and the honeymoon period is 6 months, then pay off $1,000 per month.

Standard Interest Rate
After the honeymoon period is over, a standard interest rate will apply. If you don’t pay off the full amount on your credit card each and every month, this is the interest that the creditor charges on the carry over amount – and this can add up to be quite a lot!

The best way to manage a credit card is to fully pay it off every month, so you don’t attract any interest charges. Remember, this is how the banks make their profits!

Penalty or Default Interest
If you make late payments or exceed your credit limit, some creditors will apply a penalty charge (up to 30%!) to the over run. Make sure you know what this charge is, as it can significantly add to your debt if you ever default in payment.

Grace Period
Most credit cards give you a grace period (typically around 25 days) before charging interest on a purchase. These are the best types of cards because as long as you pay off the full amount of your credit card statement every month, you’ll never pay interest. This makes these credit cards very convenient and flexible, without costing you a lot in charges.

Other cards however – the ones to avoid - start charging interest on the day you make your purchase. Make sure you find out the terms of your car

Minimum Repayments
On your credit card statement, there will be a minimum repayment. This is the minimum amount you need to repay by the due date to avoid penalty charges.

Whatever you do – DO NOT ASSUME THAT THIS AMOUNT IS ENOUGH TO PAY OFF YOUR CREDIT CARD BILL. Because it’s not. It may cover the interest charges on what you owe, but in many cases it doesn’t even cover that.

So if you only make the minimum repayments you could well end up paying interest on your interest charges and see your credit card debt increase even if you don’t make any more purchases with the card.

It is REALLY important to pay off as much of your credit card debt as you can afford – and preferably pay it in full every month to avoid the costly interest charges.

Credit Card Limit
All credit cards will have a maximum spending limit that you can’t exceed. Or if you do exceed the limit, you will get hit with a penalty charge or fee.

Some creditors will offer you a higher credit limit to ‘give you more flexibility’ – in other words, spend more money and potentially earn the creditor more interest charges when you can’t repay!

Pick a credit limit that matches your budget – that way, when you hit your limit you know you shouldn’t spend any more! And don’t be tempted by offers to increase this limit beyond what you’re able to afford.

Transaction Fees

Some shops and retailers – including some on-line merchants – will charge a transaction fee of a couple of percent if you use a credit card. This is because there is a cost to the retailer associated with processing the purchase.

Many shops will just absorb this cost, but some don’t. It pays to know whether your purchase is going to attract a transaction fee, as this can add up on larger items. Also on larger purchase such as furniture, using a credit card (or in-store finance) for these purchases limits your room to haggle for a better price. Pay by cash in these cases to get the best deal.

Annual Fees
Some cards charge an annual fee and others don’t. Just know what you are expected to pay and what you get for this.

Cash Advance
You can draw money on your credit card – and it’s sometimes convenient to have cash.

But pretty well all credit cards either hit you with a higher rate for cash withdrawals or apply interest from the date of the withdrawal. So getting cash in this manner may cost you more than just getting it out of your bank account.

Secured Credit Cards
Secured Credit Cards – or debit cards - are secured by money you have on account with the issuing bank.

Your credit limit is what you have in your bank account – so if you don’t have the money you can’t spend it. The advantages of a secured card are that you have the flexibility of using a Visa/ MasterCard but you are restricted from spending more than you have so you just can’t go into debt and get hit with high interest charges.

In summary – it’s important to read the terms and conditions of your credit card so you know exactly what fees and charges you’ll be hit with. And if you’re looking for a new card, make sure you compare the many available products on the market. Don’t get suckered in by tempters – look at the long term implications of having a particular card and pick the one that best suits your needs.

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We are not certified financial planners or advisors. The information in this website is general information only. Always consult a licensed financial planner before making any finance or investment decision.

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