Credit Cards

Introduction

Owning a payment card can be a very positive experience, as long as it is used responsibly. They have many advantages, but can get their users into financial hot water if abused. A few simple tips on proper credit card use can, however, help customers to get the most out of their "plastic friends". The key is to learn proper credit card use, before applying for credit or making other major financial decisions.

Banks offer two broad types of payment cards:

1. Debit cards that can be used to make purchases or withdraw cash from a current account up to an agreed overdraft limit (see Current Account). There is no interest involved and no monthly payments to worry about.
2. Credit cards enable holders to borrow money from the bank in order to purchase goods and services or as cash. They should be thought of as lines of credit whose limit is set out in the contract with the bank.

Benefits of credit cards

In recent decades, credit cards have become the preferred method of personal payment around the world. This is because they are easy to use, convenient, relatively simple to obtain, and facilitate otherwise unaffordable purchases. Some ways credit cards make life easier include:

• Allowing payment to be staggered over time
• Making it easy to reserve hotel rooms, book plane tickets, pay for goods and rent cars at a distance, especially over the internet
• Eliminating the need to carry cash
• Improving security, as unauthorized credit card use is easy to block
• Offering better exchange rates and lower transaction fees than foreign exchange services
• Allowing multiple family members to have cards on the same account

How do credit cards work?

A card holder who wants to buy something gives the credit card to the seller, who checks if it is valid and puts it into a point-of-sale (POS) terminal. To complete the transaction, the card holder must either sign a receipt (called a "slip") or enter a PIN code. The PIN is a personal identification number unique to the card. The card holder should check the amount first. Once the transaction has been approved, two slips are printed, one for the seller, the other for the card holder.

To withdraw cash from an ATM (an automated teller or cash machine), the card holder inserts the card in the ATM and follows the instructions that appear on the screen. Normally, the user has to enter the PIN code and specify the desired amount. As well as issuing the cash, the ATM prints a receipt (no need to sign) with details of the transaction. Receipts should be kept as a record of transactions.

To prevent stolen credit cards being misused, ATMs retain the credit card if the wrong PIN is entered three times. Should that happen by mistake, the card holder should inform the bank that owns the ATM and ask for the card back.

Credit cards are lines of credit and the issuing bank limits how much the client can spend using the card (whether to make purchases or withdraw cash).

The bank sends a monthly statement for each credit card. The statement lists all payments over the month, as well as any debt carried over from the previous period. The bank may allow a "grace period" during which no interest is charged on new debt, so long as payment is made before the end of the grace period.

The card holder may decide to pay off less than the total debt incurred. The customer must make at least the "minimum payment" specified on the statement, but may opt to pay more or even the total amount. The bank charges interest on any outstanding debt in accordance with the terms in the credit card contract.

Costs related to credit cards

The conditions and rules for use are set out in the credit card contract signed between the client and the bank. The contract should contain details on the full range of fees, costs, penalties and the terms for adjusting the interest rates as well as the rates to be applied in the case of late or deferred payment, which are applicable for the lifetime of the credit card. The client should study the credit card agreement and make sure they understand all fees and rules. Any information or calculations the client finds unclear should be explained fully by a bank representative. Before signing any contract, the client must have a clear understanding of:

• The interest rate charged on outstanding debt after any "grace period": interest is usually calculated on a daily basis over the month. In some cases, banks may apply an increasing interest rate over time and the client should be fully informed of any such possibility.
• Any late payment fee charged if payment is not made before the deadline specified in the monthly statement: some banks may apply a higher interest rate for clients who are frequently late with payments.
• The foreign exchange fee for transactions in currencies other than KM (Euro, US dollar, Swiss franc, Pound sterling, etc.).
• Any cash advance fees charged for using a credit card to withdraw cash from an ATM or in the bank.
• Any monthly or annual membership fee charged for the credit card facility.

Fees and charges are either fixed or calculated as a percentage of the relevant transactions or a combination of both (e.g. fees for cash withdrawal might be either 4 EUR or 2% of the transaction amount, whichever is higher).

Costs of goods paid for with credit cards

How much goods bought by credit card actually cost will depend on the dynamics of repayment. If the debt is paid off within the grace period, no interest is charged. When a client has existing debt and/or pays off less than the full amount, interest will be charged on any outstanding amount. So long as the debt and associated interest is cleared within a few months, the overall costs should be relatively modest. For longer-term borrowing, however, interest payments can be very high. The following example makes this clear.

Suppose a client purchases 3000 KM worth of goods with a credit card that charges monthly interest of 1.25%. The repayment period and total interest payment will depend on the monthly payments. Paying 150 KM a month will take 23 months to repay and the interest would total 450 KM. Paying 350 KM a month would take only 9 months and the total interest would be 150 KM (one third).

If our client opts to pay the minimum (often set at 5% of the total debt), the repayment period will be very lengthy and the interest charged very high. Clients should be aware of these total costs (debt + interest payment) before making a purchase, if repayment will not be made within a few months. Paying off interest over the long haul can substantially increase the cost of purchases.

Where credit card debt has already reached unmanageable proportions, the card holder will have to consider the following few steps:

• Make a plan to work down the debt by both focusing on debt repayment (primarily interest payments) and reducing current spending
• Ensure monthly payments exceed the minimum amount
• Use cash for current spending
• Negotiate a lower interest rate with the bank for the remaining debt

How to use credit card without being abused by it

The card holder must be in control of all credit card accounts and balances, actively managing them to avoid incurring the fees or charges that mean paying more. Making the effort to follow these few simple steps will ensure using credit cards is an enjoyable experience.

• Read with attention. The best advice is to read the terms and conditions of the credit card before signing up for it. The client should know not just the interest rate, but how the credit card company can raise it. Be clear on all the fees associated with using the card, including fees for exceeding the agreed limit, fees for cash advances and late fees, etc.
• Limit credit card use: Credit card usage can be kept under control if the holder sets an upper limit for using the cards. The limit should be an amount that can be paid off by the next due date. The budgeted amount should be determined before starting to use the card. Once the limit is reached, stop using the card. Using cash (or a debit card) for current spending is another good way to limit credit card use. A good use for spare cash is to pay off credit card debt.
• Stay organized. Find a method that ensures payments are made on time. Use a simple calendar - of the old-fashioned paper kind or on the computer. Take advantage of any protection against theft or illegal use offered by the credit card supplier.
• Pay by the due date. Clearing the balance by the due date to avoid late fees and other charges will prevent purchases costing more than the price on the tag.
• Keep a record of all expenditures. Keep bank statements, receipts and slips in a safe place and calculate deposits and withdrawals at the end of each month. If they don't add up, contact your bank to resolve the situation. It is not uncommon to find you have forgotten a payment made with the card.
• Prevent unauthorized use. This is a widespread problem, mainly due to theft. The best way to avoid losing credit cards is to keep them in a wallet, separate from other papers. Make sure there is no one watching when you type your PIN and never share it with anybody. Unauthorized use is not just theft. Never give young children a credit card number or PIN. In fact, never give anybody the PIN.
• Keep records of important information. We all have so many things to remember and keep track of, not least our credit card details, including the name of the issuer, the expiry date, the credit card number and PIN, and the help-line phone number. It is a good idea to have everything written down in a safe place, like a deposit box or mobile telephone - some telephones have a special notebook feature that can store data safely.