How Credit Cards Work: A Beginner's Guide

If you are just starting your journey to improve your finance habits, one of the most fundamental questions you may have is this — What is the meaning of a credit card, and what are the key things you should know before you own one?

Of late, the number of credit card users in India has begun to grow at an exponential pace. In the financial year 2020-2021 alone, there were around 62 million active credit cards in the country.

So, what makes these cards so popular? And should you get one for yourself? This blog covers what credit cards are, how credit cards work, and what you must keep in mind before applying for one.

What is a Credit Card?

• Simply put, a credit card is a financial tool allowing you to purchase products and services. When you use a credit card to purchase, you essentially borrow money from the financial institution that issued the card. And since you’ve borrowed funds, you’re required to repay it within a specified period.
• If you don’t repay the borrowed amount within the due date, interest at a certain percentage is levied on it. This can be highly useful when you need to purchase but are short on cash.
• Financial institutions issuing credit cards usually impose a limit, known as the credit limit, on the maximum amount of borrowing that you can make. This limit is decided after taking factors like your income, age, and more into account. You can continue to make purchases on your credit card till you reach the credit limit.

How Does a Credit Card Work?

Now that you’ve understood the meaning of a credit card, let’s look at how it works. Here’s an example to help you understand it better. Let’s say, you were assigned a credit card with a limit of ₹1 lakh.

As long as you repay the due on or before the stated date, you would incur no other charges or interest. However, if you miss the due date, interest at a certain percentage will be charged on your outstanding amount, which is ₹ 25,000, till you make the payment.

Eligibility and Documents for Credit Card

Below is the general information on eligibility and documentation for credit cards in India. These may change from bank to bank and provider to provider.

Eligibility Criteria

1. Age: At least 18 years old (varies for premium cards)
2. Income: Minimum monthly or annual income (varies by bank and card type)
3. Credit Score: Good credit score (typically 700 or higher)

Required Documents

1. Identity Proof
2. Address Proof
3. Income Proof (Salary slips, IT returns, etc.)
4. Passport-sized photographs
5. PAN Card
6. Application form (provided by the bank)

Please note: Specific document requirements and eligibility criteria can vary among banks and credit card types. Hence, checking with the bank you're interested in for precise details is essential.

Credit Card Annual Fees and Charges

• Credit cards come with various fees and charges. The finance charges, which are the rate of interest charged on cash withdrawals and unpaid outstanding dues, are the most significant one that you should be aware of.
• In addition to finance charges, other fees are associated with credit cards. Annual fees, balance transfer fees, cash advance fees, over-limit fees, late payment fees, and foreign transaction fees are a few of the other charges levied.
• It is essential to be aware of the charges applicable to the card you wish to apply for since it can help you make a more informed decision.

Advantages of Credit Cards

The most common advantages of credit cards include:

1. Convenience: Credit cards offer a convenient way to make payments without carrying cash.

2. Build Credit: Responsible credit card use can help build a positive credit history, which is essential for loans and financial transactions.

3. Rewards and Cashback: Many credit cards offer rewards, cashback, or discounts on purchases, providing cost savings.

4. Security: Credit cards offer fraud protection, and liability for unauthorized charges is typically limited.

5. Interest-Free Period: Credit cards often provide an interest-free grace period for repaying purchases, usually around 20-50 days.

6. Emergency Funds: Credit cards can serve as a financial backup during emergencies or unexpected expenses.

7. Travel Benefits: Some credit cards offer travel perks, such as insurance, airport lounge access, and discounts.

8. Record Keeping: Credit card statements provide a detailed record of spending, aiding in budgeting and expense tracking.

Different Types of Credit Cards and their Unique Features

Below are the different types of credit cards:

• Lifestyle credit cards
• Travel credit cards
• Shopping credit cards
• Cashback credit cards
• Co-branded credit cards
• Business credit cards

Let’s understand their features and benefits in detail:

How Does Using a Credit Card Affect Improving & Building Credit Score?

• Your credit score is one of the many metrics that financial institutions take a look at when you apply for a loan or a credit facility. The higher your credit score, the more trustworthy you’re deemed to be, which can help you land very attractive loan offers.
• Did you know that the way you use your credit card has a significant impact on your credit score? Yes, that’s right. When you use your bank credit cards for purchases and pay your dues back in full before the due date, your credit score goes up.
• On the other hand, when you fail to repay your dues in full on or before the said due date, your credit score takes a huge hit.

Best Practices for Managing Credit Card Debt

Using a credit card could mean convenience but it also needs to be dealt with caution. Below are some of the best practices for managing credit card debt:

• Pay On Time: Always make at least the minimum payment by the due date to avoid late fees and damage to your credit score.
• Pay More Than the Minimum: Whenever possible, pay more than the minimum to reduce the principal balance and interest charges.
• Budget Wisely: Create a budget to track your spending and ensure you can afford your credit card payments.
• Avoid Minimum Payments: Avoid making only the minimum payments as it can lead to long-term debt and higher interest charges.
• Prioritize High-Interest Debt: Focus on paying off high-interest credit card debt first to minimize interest costs.
• Limit New Charges: Minimize new charges on your credit card while paying down existing debt to prevent further accumulation.
• Emergency Fund: Build an emergency fund to cover unexpected expenses without relying on credit cards.
• Negotiate Interest Rates: Contact your card issuer to negotiate lower interest rates, especially if you have a good payment history.
• Review Statements: Regularly review credit card statements for errors or unauthorized charges.
• Consolidate Debt: Consider debt consolidation if you have multiple credit cards with high balances.
• Seek Professional Help: If you're overwhelmed by debt, consider credit counseling or debt management programs.
• Avoid Closing Accounts: Closing credit card accounts can impact your credit score, so consider keeping them open with a zero balance.

Credit Card Interest Rate Calculator 

Fi's credit card interest rate calculator helps you calculate how much interest you will pay on your credit card balance over a certain period of time, if you don’t pay the whole amount. You can use this calculator to see what happens if you pay just the minimum amount or any other amount that’s lesser than the whole amount due.

Try it for yourself:

Let’s say you plan on buying an iPhone, but do not plan on paying the whole amount due on your credit card at the end of that month. And let’s say you continue using your card every month thereafter. This credit card interest rate calculator then tells you how much you’ll have to pay as interest at the end of a certain number of months, giving you a sense of your repayment duration.

Conclusion

A credit card is one of the best payment methods that you can use. It allows you to purchase your favourite products and services and pay for them later. Additionally, you also get to enjoy several rewards and discounts for using your card And get to build credit history and increase your credit score.

Frequently Asked Questions

1. What is a credit card and what are its uses?

A credit card allows you to pay for products and services even when you don’t possess the required funds. The amount of money that you spend on a credit card has to be repaid on or before the stipulated due date.

Also, paying for expensive products and services is more convenient with a credit card since you don’t have to carry large amounts of cash with you. Other uses of a credit card include the ability to avail loans against it, convert large purchases into more manageable instalments, and keep a track on your expenses.

2. How to use a credit card?

To use a credit card online, all that you need to do is choose the ‘credit card’ option at the payment gateway, enter the details of the card, and proceed to make the payment.

To use it offline, simply insert the card into the card reader machine and enter your card’s four-digit PIN to make the payment.

3. What are fees or charges in a credit card?

Finance charges is the rate of interest that’s charged on cash withdrawals and unpaid outstanding dues on a credit card. It is often represented as a percentage per month or percentage per annum.

4. Why is it important to have a credit card?

Credit cards are important tools in building a good credit history - this helps in loan approvals and getting better interest rates on it. Credit cards also offer convenience and flexibility for making purchases, especially online and while traveling. They also offer multiple discounts and rewards and can help in building a good financial plan.

5. How can I build and improve my credit score using a credit card?

To build and improve your credit score using a credit card:

• Get a credit card.
• Pay on time.
• Use credit responsibly.
• Avoid carrying balances.
• Diversify credit types.
• Monitor your credit.
• Avoid opening too many accounts.
• Be patient and consistent.

6. What factors should I consider when choosing a credit card?

When choosing a credit card, consider the interest rate, annual fees, rewards and benefits, credit limit, credit score requirements, and any additional terms and conditions that may impact your financial goals and spending habits.

Want a Credit Card That Gives You The Best Bang For Your Buck?

If you're looking for a credit card that gives you the best bang for your buck, the Fi-Federal co-branded Credit Card is what you need. With this card, you're assured of a 2% valueback through rewards. But that's not all, as you'll also get 5x on your top 3 brands, 2x on all partner brands listed in the Fi Collection and 1x on everything else, including rent and fuel. What's unique is that you earn points through Fi-Coins. For travellers, the perks are even better, as you can convert your Fi-Coins to airline miles or cashback.

But that's just the tip of the iceberg: you'll also enjoy airport lounge access, 1% forex, the freedom to choose your billing cycle, and personalised reminders. With consolidated spend insights, you can easily track your spending and make informed financial decisions. Oh, and the welcome offer includes exclusive vouchers from top brands worth ₹5,000!