What are Credit Cards?

A credit card is a plastic card with a magnetic strip on the back. Credit cards are carried by the majority of consumers in the United States. Holders of such cards have the ability and authorization to purchase goods and services on credit.

All credit cards are issued by financial intermediaries, such as banks. Furthermore, all credit cards are attached with a credit limit. Users or holders of credit cards cannot go beyond the prescribed cred limit.

In order to obtain a credit card, a consumer must undertake a credit card application process. The applications and the requirements to obtain the credit card will vary based on the banking institution. However, each application will require personal information as well as a review of the individual’s credit history. A credit history refers to the consumer’s financial past and more specifically their ability to repay loans or credit payments.

When an individual purchases a good or service with a credit card they are paying for the product in good faith, meaning there is no exchange of liquid funds for the obtainment of the goods. Rather, the item is purchased with the understanding that the consumer will pay (in full) the amount owed for the products purchased.

When a purchase is made via a credit card, the vendor obtains the underlying credit card’s information from the holder. The bank issuing the card will reimburse the vendor for the products purchased, and eventually the cardholder will repay the bank through periodic monthly payments.

Financial institutions make money through the issuance of credit cards because each purchase is attached with interest payments. In addition, if a holder fails to make their payments on time, the issuer of the credit card will charge a fee.

Individual financial institutions (entities who issue credit cards) possess their own policies in regards to credit card applications.

Consumers who apply for a credit card may seek a secured or unsecured form of credit. A secured credit card will require the applicant to deposit an amount of cash equivalent to the card’s credit limit. This deposit requirement offers the financial institution security.

If the consumer fails to make sufficient payments, the institution will use the deposited money to pay off the credit card debt. In contrast, an unsecured credit card, which is typically issued to consumers with good credit history, does not require a deposit.

Credit limits are determined on an individual basis and are typically raised or lowered based on the holder’s ability to pay off their debts. Credit cards become problematic when the user of the card amasses debt that exceeds their ability to repay.

The laws which govern credit card use regulate interest rates and the amount of late fees delivered by the underlying financial institution. The Federal Reserve has issued rules and detailed guidelines for implementing each phase of credit card law.

Currently, financial institutions operate with limited interest rate hikes, limited universal default, and the right for the consumer to opt out of their current credit contract. Additionally, as a result of the economic collapse, the Federal Reserve has instituted laws which allow individuals more time to pay off their monthly bills and limit the amount of fees attached to late payments.

NEXT: Discover the Workings of Credit Card Processing