Credit cards are instant personal loans. By swiping a credit card with a magnetic strip when making a purchase, a person immediately borrows funds from a financial institution. With a credit card, there's no need to have cash on hand for a transaction. Typically, this short-term loan is paid back on a monthly basis at a relatively high interest rate.
1920s: Credit cards were first used in the 1920s when American companies (like oil companies and hotels) began issuing them to customers to make purchases at those businesses. The businesses themselves issued credit directly to their customers. Early credit cards weren't the rectangular pieces of plastic we know today -- early credit cards were metal coins, fiber, or paper.
1950: As credit card use became more popular after World War II, Diners Club issued the first universal card for customers to use at a variety of different businesses.
1958: American Express launches
1959: Bank of America begins issuing the BankAmericard, which functioned with the banking system we use today. Cards are swiped at a merchant and that merchant is paid by a bank relatively quickly. Credit holders then pay off their balance to the bank who issues the card.
When you're issued a credit card, it comes with a credit limit. Credit cards are really revolving credit lines -- you get a certain amount of credit you can use (your credit limit) and you can draw on it and pay it back whenever you like. In return for this relatively easy access to money, credit card companies charge high interest rates on the money you borrow. If you pay back what you spend each month, you won't be subject to the high interest rates. If you don't pay back what you borrow and carry a balance on your card, you'll be charged interest on this sum.
Credit cards are generally the easiest way to borrow money. Credit cards are accepted around the world by millions of businesses (estimated about 9 million businesses in the U.S. alone that accept credit cards). Given how easy credit cards are to use, their role in personal finance is important. Responsible personal finance dictates that people live within their financial means -- credit cards can encourage excess spending.
Who uses credit cards
Credit card use has dramatically risen over the past decade.
- The average age of a person getting her first credit card is 21 years old.
- 76% of college undergraduates have a credit card
- 60% of card holders have a card with a reward program
- There are 176.8 million Americans with credit cards
- 1.5 billion credit cards are in circulation in the U.S.
Among individuals in the U.S. with credit history, there's an average of 3.45 credit cards per person. Or, from a different perspective, there are 383 million open credit card accounts.
In addition to the interest you'll pay on your credit card balances, there are other fees to consider when you use a credit card. Here are a few of the most common:
Application fee: Some credit card issuers charge you to apply for a credit card.
Yearly fee: Some card companies charge holders of their cards a yearly fee. This fee can range from $25-$300 -- there are some elite cards that are higher -- and can be frequently waived if you request it. This can also be called a subscription fee, membership fee, or participation fee.
Cash-advance fee: Many charge cards allow you to withdraw cash from your credit limit. To do this, they may charge a set fee (say, $3) or a percentage of the cash-advance (say, 3%).
Balance transfer fees: To encourage new people to sign up, credit card companies generally encourage balance transfers from competitors onto their cards. This can either be a flat fee or a percentage of the transfer depending on the card.
Late payment fee: If you're late making a payment to your credit card company, you'll likely be assessed a late payment fee.
Over-the-limit fee: If you max out your credit limit and attempt to charge even more to your card, the transaction may be rejected and you may be subjected to an over-the-limit fee (like an overdraft fee on a savings account).
Sources: Federal Reserve
As the popularity and use of credit cards has grown, it's obvious that fraudulent activity would be on the rise. And actually, signing the card after you pay for something isn't some miraculous security protection for you, the consumer. It's actually for the benefit of the merchant and has everything to do with who's liable.
Assume your card is stolen and Joe Thief heads to his favorite coffee shop and pays for a $5 latte using your credit card. Later on, when you contest the charges, If the coffee vendor can produce a signed receipt, he won't have to eat the $5 charge. Instead, the bank does.
Visa accounts for 36% of all issued credit cards in the U.S. MasterCard (27%), American Express (6.5%), Discover (7.2%) and others (23.3%) account for the rest.
As of March 2013, there was $846 billion in revolving consumer credit in the U.S. That works out to be an average $7,073 in credit card debt per household.
This number is down from a high of $8,740 of debt per household in April of 2007.
Take a good look at your credit card -- there's a lot going on. Here's what it all means.
Account number: The big series of numbers that spans the center of your credit card is your account number.
Major Industry Identifier: The 1st digit in your account number refers to the category of business that issued your card (1 and 2 are airlines, 3 is travel and entertainment, 4 and 5 are banking and financial, 6 is merchandizing and banking, 7 is petroleum, 8 is telecommunications, and 9 is national assignment)
Issuer Identification Number: The first 6 digits are called the Issuer Identification Number which identifies the institution that issued the card (Visa starts with 4xxxxx, Mastercard with 5xxxxx, Discover with 6xxxxx, and Amex with 3xxxxx). Merchants and banks can use the Issuer Identification Number to look up a card.
Final digit: The last digit in your account number is generated using something called the Luhn algorithm. This is a mathematical formula used as a security precaution by confirming the previous digits in the account number sequence. This prevents casual attempts at generating fake credit card account numbers.
Issuing bank logo: Most credit cards display the logo of the bank that actually issued your card. This can be confusing because your relationship may be with the bank that does the processing of your payment, not the one who lends you money (the issuing bank).
Card brand logo: Logos of credit card processors like Visa or Mastercard show up on your credit card.
Cardholder name: This is the name of the person, business, or organization to which the credit card is issued.
Hologram: Credit card manufacturers frequently include some type of hologram to identify a card against counterfeits.
Expiration date: This is the period through which your credit card is valid. Usually, it's a month and a year -- occasionally includes a day of the month.
Card Verification Value: This is a three-digit number (four for Amex) that appears on the back of a credit card, usually in the signature line. Because this number doesn't appear anywhere else on the card, businesses use this to ensure that the owner of the card is in possession of the card when making a purchase over the phone or online.
Stories of massive credit card frauds aren't common, but they do happen (like this one in early 2013). The Federal Trade Commission estimates about 9 million Americans are victims of identify theft each year.
So what can you do to protect yourself and your credit cards against theft or fraud?
Protect your data online: Clear logins and passwords if you work on public computers. Changing logins and passwords regularly is also a good habit.
Use credit cards for online purchases: Your credit card company more than likely providers stronger protection for you than a debit card or online payment provider would.
Keep your phishing line out of the water: Phishing occurs when someone impersonates a friend or a business, asking you to update your billing information. These schemes are hard to detect, so be alert that this is happening and only update your personal information by going directly to your credit card company's website.
Monitor your credit reports and statements: Review your credit card statements and credit reports regularly to sniff out suspicious activity.
Shred important documents: Consider investing in an inexpensive office shredder to destroy documents with sensitive info, like your monthly credit card statement.
Sources: Wall Street Journal
With the popularity of credit cards, competition for your business has heated up. One way credit cards compete with one another is by offering rewards for using their cards. These rewards programs can benefit you by giving you cash back or other cash-like rewards such as airline miles or credits towards groceries.
Here are a few example credit card reward programs:
Cash-back: Some credit card reward programs offer cash back for using their cards. You gain points based on how much you spend on a card. These points are redeemable into cash, such as 5% cash back off of the total purchases you made during a month.
Mileage: Many airlines offer credit cards with point systems that are redeemable into miles in their frequent flier programs. If you fly one airlines a lot, you can rack up miles by paying for things you pay for anyway.
Gift-rewards: Other reward programs can be redeemed into gift cards to be used at various retailers. Often, big retailers offer their own credit cards with incentives to spend money at their stores. Gas station chains offer something similar to promote their product to their card holders.
Doing good through charity: Some rewards programs enable you to direct points, miles, or cash to charitable causes.
The credit system rewards good credit. That means it's easier to get approved for credit cards once you have a good credit rating. But what if you don't have any credit history yet?
Here are a couple of ways to get a credit card even with no credit:
Prepaid and secured credit cards: The easiest way to start building credit is to get a prepaid credit card. Prepaid cards require you to load them first with money. When you use a prepaid card, you spend down this balance (with no worries of overspending). Secured credit cards require you to deposit collateral first before you start using the card. Make sure you check that the prepaid card company reports your credit -- some cards do, others don't. After around 6 months of using a card like this, call your credit card company and request to be approved for a standard card.
Find a co-signer: Someone with no credit could be approved for a credit card if she has a co-signer with good credit history. This is a tricky relationship: while you can use the stability and good credit of your co-signer to get approved for your loan, the co-signer can be impacted if you don't borrow/spend responsibly.
Optimize your rewards programs: Different credit cards offer vastly different rewards programs. Try to mix up your usage of the different credit cards to carry to take advantage of the benefits each individual card offers. For example, various airlines offer credit cards offering incentives towards future flights when you use their cards to pay for airfare.
Protect yourself against theft/loss by using different cards: Use one credit card to automatically pay recurring monthly charges while using another to pay for in-person transactions. This way, if one card is lost or stolen, it's easier to handle and manage setting up a new one and transferring payments to that card.
Use a zero interest card to pay off other cards: If your credit score is respectable, you can get approved for a zero interest card (generally, a special rate for 18 months). Transfer your existing balance on a higher interest rate card over to the zero interest card and get to work paying off your balance. The nice thing is that you won't be paying 20+% interest rates while you do. Check the fine print -- there's generally a fee to transfer a balance (around 3%) which would be worth it if your outstanding balance is big.
Credit cards have been in use for almost 100 years. Since then, we've seen a tremendous shift away from paper money on to plastic. But we're not stopping there. Here's a little taste of the technologies that will change the way we use credit cards in the future:
Contactless cards: Right now, most of us are very accustomed to the credit card swipe. A swipe is required in a credit card reader to be able to read the information stored in the magnetic stripe. But that's so last century. New technologies like NFC (Near Field Communications) place a chip in the card that actually transmits your information to a specified reader.
Mobile payments: While mobile payments are still in their infancy, it won't be long until your credit card information is embedded in your phone. Wave your phone in front of a cash register or bump it into someone else's phone and there will be a whiz-bang-poof payment.
Dynamic magnetic stripe cards: Card technology provider Protean developed the Echo card, which will enable us to reduce all the multiple cards we carry into one uber card. It works like this: you use your smartphone to scan the magnetic stripes of your existing cards. This information is then stored onto a dynamic magnetic strip on the Echo card that can store up to 3 credit cards onto one piece of plastic.
Dynamic display cards: MasterCard recently unveiled its Display Card which has a small LCD screen and touch-sensitive buttons. Card holders will eventually program one-time passwords, check balances, or inquire about recent transactions all on the card itself.