Bank Credit Cards
Banks are in the business of lending and one form of lending is through credit cards. These cards are essentially unsecured lines of credit. Customers love credit cards because of their convenience. They can be used almost anywhere to make purchases.
Customers can delay payment on the purchases for several weeks or they can pay a small amount each month until the purchases are paid off. Banks love credit cards because they can make money on both fees and interest, making them very profitable in an industry that is known for having very tight margins.
MasterCard, Visa, American Express and Discover
These logos are found on credit cards and indicate a third or fourth company involved in the credit card transaction. The simple swipe of a credit card involves several parties. For MasterCard and Visa there are four parties involved, for American Express and Discover there are three. The bank issues the card to the cardholder.
In the case of Discover and American Express they operate their own cards so this eliminates the bank side because they are acting as the bank as well. The cardholder and the merchant have the purchase exchange which includes two parties. Then the card is processed through either MasterCard, Visa, American Express or Discover.
When a purchase is made using a credit card the merchant is charged a fee for providing customers with the convenience of being able to use a credit card. This fee is divided among the bank and the card processor (MasterCard, Visa etc.). So even if the customer pays the card in full every month and never pays the credit card any interest, the credit card bank and processor is still making money off the fees they get when the credit card charges are processed.
Paying for Convenience
With a credit card essentially being an unsecured line of credit, the interest rates are often very high. Even for those with excellent credit rates can range anywhere from 7% to 29.99%. The rate is determined by the credit worthiness of the credit card holder. The other significant factor to the rate also include the benefits found on the card or the rewards program that is offered. Many times, great rewards programs will charge higher rates of interest.
Paying an Annual Fee
Basic credit cards for customers with good credit generally do not come with an annual fee. The annual fees are found on two types of cards. The first is the cards issued to those with bad credit. These cards come with an annual fee and a high rate of interest. This is to compensate for the poor credit of the applicant. The other cards that charge annual fees are cards given to those with excellent credit, but have significant benefits or rewards. Hotel cards that offer free nights every year or airline cards that give big upfront bonuses and annual miles bonuses come with annual fees.
When looking at an annual fee it is important to determine if the benefit is worth the fee. If the cardholder gets a free or $99 companion airline ticket which can save hundreds of dollars, then an $89 fee is a bargain. If the cardholder gets one or two free room nights every year that can save the customer hundreds, the card still offers enough value to warrant the fee. The cost to the hotel chain or airline is low, yet the benefit to the consumer is high. When this occurs annuals fees make sense to pay.
Other Fees to Consider
Credit card terms are filled with very strict rules and fees attached to each rule that is not followed. The card has a payment due date. If that date is missed by even one day, a late fee is charged. The cards provide access to cash advances through a local ATM. For this convenience a fee for taking out the money is charged alongside a higher interest rate. If the customer wants to transfer a balance, the bank is happy to help, but for a fee. Most cards also have a penalty interest rate. This means if the payment is late or the card goes over the limit then a higher interest rate can be charged. This rate is permanent and the customer will no longer have access to the lower purchase rate.
These fees are significant because if you ever get in financial trouble and cannot make on time payments the fees can add up to hundreds of dollars very quickly. With an unsecured line of credit banks get very nervous when a payment is missed and respond with higher penalty fees. This can make catching up even more difficult.
Why Is Credit So Important
Banks evaluate credit applications based on risk. The bank is trying to determine what the risk is that the applicant will use the card and pay the bill on time and what the risk is for default. Default is the term used when a cardholder no longer makes the payments. Since the credit card is unsecured, meaning there is no collateral for the bank to take if the payment is not made, the risk of non-payment is automatically higher. If a consumer buys a car and fails to make a payment the bank comes and takes the car from the buyer. The car is the collateral.
Because the inherent risk of a credit card is higher than most forms of credit, the banks mitigate this risk by having very strict terms and fees. They can also charge high rates of interest and annual fees to compensate for the risk.
In determining the level of risk for the applicant the bank uses income that the applicant declares, the debt the applicant currently is managing, and the credit score. Typically the applicant’s income is not verified, therefore the bank makes nearly 100% of its decision based on the information found on the credit report. This makes a credit report extremely important to the customer and the bank, because it determines access to credit.
The credit report shows how many lines of credit are currently open, what the credit limits are for each revolving line of credit, and what the current balance is for each card. It also shows loans and a payment history that stretches back for 7 years. Any judgments, collections or other missed payments are also found on the report. The other thing a report provides is job and address history. This creates a profile that banks use to determine the risk that an applicant will use the card responsibly. Improving your credit score is the best way to get better options and terms for credit cards.