Credit Card

What is a 'Credit Card'

A credit card is a card issued by a financial company which enables the cardholder to borrow funds. The funds may be used as payment for goods and services. Issuance of credit cards has the condition that the cardholder will pay back the original, borrowed amount plus any additional agreed-upon charges. The credit company provider may also grant a line of credit (LOC) to the cardholder which allows the holder to borrow money in the form of a cash advance.  The issuer pre-sets borrowing limits which have a basis on the individual's credit rating.

BREAKING DOWN 'Credit Card'

Credit cards have higher annual percentage rates (APRs) than other forms of consumer loans and lines of credit. Interest charges on the unpaid amount charged to the card usually begin one month after making a purchase. They remain one of the most popular forms of payment for consumer goods and services, and nearly every business allows for payment of products and services through credit cards.

Most Common Types of Credit Cards

Banks, credit unions, or other financial institutions issue most major credit cards. The major affiliated companies include Visa, MasterCard, Discover, and American Express. Many credit cards carry incentives which distinguish the cards from one another and make them more attractive to consumers. Many have rewards geared towards specific interests such as airline miles, hotel rooms, gift certificates to major retailers, and cash back.

A store may also issue a branded version of the major credit cards. These store-branded cards are specifically intended to promote customer loyalty. Often it is easier to qualify for a store credit card than for a major credit card. However, many store cards limit usage to purchases from the issuing retailer. Also, retailers may offer cardholders special discounts, notice of promotions, or special sales.

Secured credit cards are a kind of credit card, where the cardholder secures the card with a security deposit. These cards usually have a limited line of credit and may charge an annual membership fee. The required deposit is most often equal to the total line of credit. Frequently, those with limited or poor credit history will use secured credit cards. After repeated, responsible use, the issuer will refund the security deposit. These cards may also be known as prepaid credit cards and semi-secured credit cards.

Similar to a secured credit card, a prepaid debit card is a type of secured payment card. However, the funds available are only those which you or someone else has deposited into the account or the funds in the linked bank account.

In contrast, an unsecured credit card will not require a security deposit or collateral. These cards will have higher lines of credit offerings and offer lower interest rates on unpaid balances. The unsecured card is the most common type of credit card in the world.

Building Credit History with Secured Credit Cards

For consumers with damaged credit, a secured card can help the cardholder rebuild his or her credit while providing a way to make online purchases and eliminate the need to carry cash. Most secured cards report payments and purchase activity to the major credit agencies. If the cardholder uses the card responsibly, they might be able to extend their line of credit or upgrade to a regular credit card in the future.

While financial institutions want to protect themselves from potentially having to write off bad debt from cardholders with higher credit risks, they also recognize that higher risk individuals may one day turn into less risky individuals. Extending credit may thus allow the financial institution to create more business, as well as earn interest on the credit that a semi-secured cardholder borrows against.