The usage of credit cards in the African landscape is on the rise, and many are yet to be well acquainted with the difference between a credit card and a debit card.
Both are given by banks, they look the same and they seem to perform the same functions – they can be used at ATMs, at malls, and to make online purchases.
So what is the difference?
Having and using a debit card depends on the amount of money you have in your bank account. When you have money in your account, you can use the card to make purchases, withdraw money from the ATM and pay your bills using the card directly from the money you have in your account. When there is no money, you cannot use it.
A credit card, on the other hand, allows the user to spend money that they currently do not possess in their account against a line of credit, which is the card’s credit limit. The card’s credit limit is agreed upon when the credit card user enters into a contract with the bank in order to be issued with the card.
As earlier said, the card can be used while shopping or making other payments, and the cost incurred (that is the bill), will be reflected on the card’s account statement.
Logically, when the bank offers a line of credit, it charges fees and interest if you do not pay back the amount borrowed within a given period of time, usually 25-30 days which is the grace period.
The benefit of using credit cards is that
- You get to conveniently have money when in need – it could be buying a pair of shoes or spending the money to run a business.
- While using credit cards, depending on the policy, one might earn rewards and build their credit score.
- Cards are a safer and more convenient way of carrying money.
Disadvantages of using credit cards
- It is easy to sink into credit card debt if one is a carefree spender.
- Delayed or missed payments can affect one’s credit score.
- Maxing out the card negatively impacts one’s credit score.
- Interest accrues with every late or missed payment, and that could dig the credit card into debt. This is counter-intuitive to the purpose of having a credit card since the intention of having a credit card is to avoid falling into debt.
How Credit Cards work
Credit cards are issued by a bank. To acquire one, one has to apply to their bank of choice. Depending on the packages available, the one applying for the credit card will choose the one that is most preferable to their situation.
Caution is advised when choosing a credit card, since the interest rates, fees and rewards differ from bank to bank, and package to package even within the same bank.
When applying for a credit card, one should also be careful to know their spending habits. For instance, if you are disciplined financially, it is better to go for a credit card that offers points and rewards for early payment on credit taken against the line of credit. If instead, you are in a tight financial position, you should choose a credit card that has a low-interest rate, since this will be easier on your pocket.
Kindly note that delays on monthly payments generate interest that the credit card user will pay the bank, and this negates any rewards and points that could have been accrued.
So who really gains when using a credit card? The bank or the user?
When used correctly, credit cards are a win-win arrangement for both the bank and the credit card user.
Credit card user conveniently has money every time they need it. For example, if the credit card user runs a business, issues like late payment of salaries to employees can be avoided.
The bank also gains money in the following ways:
- Standard fees – these could be fees used in opening the account, or annual fees that one needs to pay to make the account operational.
- Though transaction fees. Every time the credit card user uses the card, a transaction fee is charged. The transaction fee is usually borne by the merchant who accepts the card, and therefore, the credit card user need not worry about paying this fee.
There are also types of transaction fees – such as transfer fees, cash advance fees, and foreign transaction fees. We will deal with these later in articles in the future.
- Through penalty fees. These are returned payments, over-the-limit fees, and late payments. For instance, when a late payment is made after the grace period, usually 25-30 days, interest is charged on top of that payment. Banks depend on late payments to make this money.
Credit cards should be used with caution, since when used frivolously they ruin the credit score of the user, and pile up one’s debt.
In the next article, we will deal with how to improve your credit score so that you can qualify for a credit card.