Understanding Credit Cards Better

You can go through life without a credit card, but you’d be in the decided minority. Here are some statistics that show how credit cards continue to be an integral part of our financial lives in the United States:

• People with at least one credit card: 70%
• Average credit cards per person: 2.7
• Average credit card debt: $5,331
• Credit cards in circulation: 1.06 billion

Given these numbers, it’s easy to take credit cards for granted. But many consumers have only a passing acquaintance with the world of credit cards. There’s much more to these little plastic rectangles than simply shopping without cash, as we’ll explain in this article. 

How Credit Cards Work

Credit cards allow you to charge purchases of goods and services – that is, you postpone spending cash until a later date. Beyond functioning as a cash substitute, credit cards allow you to finance your purchases by stretching out the payments over multiple months in exchange for paying interest. 

Here are some important terms you’ll need to know:

• Credit limit: The total amount of money you can charge on your credit card. Credit limits can range from a couple of hundred dollars to many thousands. If you try to spend beyond your credit limit, your transaction may be declined, and you may have to pay a penalty fee.
• Billing cycle: The credit card issuer periodically bills you for the amount you’ve charged on your card by dividing the year into a number of billing cycles (usually about a month long). At the end of each billing cycle, you’ll be sent a statement detailing your transactions, current balance, interest charges (if any), and minimum payment. You must make your payment no later than the billing due date, usually 21 to 25 days after billing cycle ends.
• Grace period: The period between the end of a billing cycle (i.e., the statement date) and the billing due date in which you can pay the entire balance without triggering interest charges. 

• Annual percentage rate (APR): The standardized way credit cards charge interest on unpaid balances. Typically, the APR is divided by 360 or 365 to produce the daily percentage rate. The credit card companies use the daily percentage rate to calculate your interest charges based upon your average daily balance subject to interest (i.e., a balance not completely paid within the current grace period). APRs can run from 10% (for secured credit cards) to 36% (for unsecured cards), with the average around 20%.
• Unsecured credit card: A credit card backed only by your agreement to pay at least the minimum amount each billing cycle. In other words, you don’t have to put up any collateral to get an unsecured card.

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The Credit Card Landscape

There are many ways to classify credit cards, and often the different classifications overlap with each other. Here are the most important components to the credit card landscape.

Brand

What we commonly think of as a credit card’s brand is actually the payment network that handles the card’s transactions. General purpose credit cards in the United States belong to one of the four major payment networks: Visa, Mastercard, American Express, and Discover. The brand and its logo are printed on each credit card. Visa and Mastercard are payment networks only. American Express and Discover are also card issuers. The market shares of the four credit card bands are:

• Visa: 52.8%
• Mastercard: 32.6%
• Discover: 8.1%
• American Express: 7.5%

Discover and American Express (Amex) trail the pack for historic reasons, namely that it costs merchants more to process these brands’ transactions than those of Visa and Mastercard. This meant that fewer merchants accepted Discover and Amex, which discouraged brand popularity. 

 Insider Tip: Nowadays, Discover and Amex are accepted at 99% of American merchant locations that accept credit cards, thanks to lower charges for transaction processing.

Issuer

The card issuer is a bank responsible for approving applications for and distributing its credit cards, extending credit to each cardholder (up to the credit limit), managing the cardholder’s account and payments, and handling all aspects of customer service. The following are the market shares of the top eight major card issuers:

1. Chase: 16.6%
2. Citi: 11.6%
3. American Express: 11.3%
4. Bank of America: 10.7%
5. Capital One: 10.5%
6. Discover: 7.6%
7. Wells Fargo: 4.3%
8. U.S. Bank 4.1%

 Insider Tip: Chase is the leading issuer because it offers credit cards with arguably the best mix of rewards, benefits, and fees, and also because of loyalty to the issuing bank, JP Morgan Chase, which is the largest bank in the United States.

Each issuer offers several credit cards, usually based on the credit type of the cardholder and the types of benefits offered by each card.

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Credit Types

Credit card issuers aim each of their credit cards at a segment of consumers within a range of credit types that are based upon the consumer’s FICO credit score.

 Insider tip: There are several competing credit scoring systems in the marketplace, but the FICO scoring system, with scores ranging from 300 to 850, is the 800-pound gorilla in the market.

The credit types correspond to the following FICO scores:

• Excellent: 800-850 (21% of consumers)
• Very Good: 740-799 (25% of consumers)
• Good: 670-730 (21% of consumers)
• Fair: 580-669 (17% of consumers)
• Poor: 300-579 (16% of consumers)

A typical credit card issuer might create different cards for good+ credit and a different one for fair/poor credit. Within each group, the issuer may further differentiate its multiple cards by fees and rewards/benefits.

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Card Characteristics

When you go shopping for a credit card, you’ll most likely pay attention to three main criteria: Costs, permitted transaction types, and rewards/benefits.

Costs 

As a cardholder, you’ll run across two types of costs: Interest and fees. Interest charges are expressed as the card’s APR (see above). You incur interest when you carry an account balance over more than one billing cycle. A card may have up to four different APRs:

• Purchase APR
• Balance transfer APR (see below)
• Cash advance APR (see below)
• Penalty APR (when present, a high APR that replaces other APRs if you miss a payment)

 Insider tip: Pay your full balance each billing cycle and you’ll avoid interest charges entirely (to the issuer’s chagrin).

Fees can be charged for a number of reasons:

• Annual fee: A membership fee simply there to make money for the issuers. The size of the annual fee usually corresponds to the target consumer credit type and ranges from $0 (for basic cards) to $595+ (for premium cards).
• Cash advance fee: Typically, the greater of $10 or 3%-5% of advanced amount.
• Balance transfer fee: Typically, the greater of $5 or 3%-5% of transferred amount.
• Penalty fees: Optional, for late payments, returned payments, and/or credit limit overages. Typically, in the $25 to $40 range per incident.
• Foreign transaction fee: Some cards charge a fee for foreign transactions, typically 1% to 3%.
• Other fees: Cards for consumers with poor credit are often festooned with nuisance fees, including ones for signup and monthly maintenance.

  Insider tip: Cards from Discover never carry an annual fee and offer competitive rewards.

Transaction Types Offered

All credit cards process purchases. Two other transaction types may also be available, and both typically charge a fee and/or may charge a special APR:

• Balance transfers: Allows you to consolidate credit card debt by transferring your card balances from other cards. 
• Cash advances: Allows you to borrow money from your card, up to the cash advance limit (usually a portion of the overall credit card limit).

  Insider tip: Both optional services charge interest from the first day – they have no grace periods (unless interest is waived because of a special promotion).

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Credit Card Rewards/Benefits

Most credit cards offer some mix of rewards and benefits.

A card that offers rewards on purchases is called, naturally, a rewards card. Rewards can be denominated in dollars, points, or miles. If denominated in the latter two, the card is probably a travel card (i.e., a card with rewards and benefits geared toward the needs of travelers).

Cash back cards offer dollar-denominated rewards. Points cards offer points that can be used for purchases or converted into cash or miles. Miles cards are usually associated with a co-branded airline and offer the frequent flyer miles of that airline, but a few travel cards offer their own proprietary miles that you can transfer to an airline frequent flyer program.

Rewards may be earned at a flat rate on all purchases. However, many cards offer multiple reward tiers with higher rates on purchases from selected merchant types. Some cards offer higher rewards on a quarterly rotating basis. There are merchant types and reward limits for each quarter.

  Insider tip: You must register each quarter to earn the higher rewards.

Among the many benefits available from credit cards are various free types of discounts, insurance, protections, warranties, and special services. Two promotional benefits are aimed at new cardmembers:

• Signup bonus: You can earn bonus rewards when you spend a specified amount on purchases in the first three months after account opening
• 0% introductory APR: No interest charged on purchases and/or balance transfers for the first 6 to 18 months (or more) after account opening.

Cards may offer one, both, or neither of these promotional benefits.

 Insider tip: Get a new card with a generous 0% introductory APR when you contemplate a big-ticket purchase.

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6. Cash Advances and Balance Transfers Charge Fees

You might sign up for a card featuring an 18-month 0% introductory APR for balance transfers. You can consolidate your other card balances to your new card and avoid interest for 18 months, but each transfer will cost you from 3% to 5% of the transferred balance. That’s up to $50 on a $1,000 transfer.

If you would like a cash advance, be aware that:

• You will probably be charged a fee of at least 3%.
• Your cash advance APR might be considerably higher than your purchase APR.
• There is no grace period for cash advances. Interest accrues from the first day.
• Your cash advance limit may be much smaller than your overall credit limit. For example, many cards set the cash advance limit at 30% of the credit limit.
• Cards for bad credit might not offer cash advances.

Bottom Line: Always read the fine print before signing a credit card agreement. What you don’t know can hurt you!

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