Although most people refer to those shiny pieces of plastic in their wallets as "
credit cards", some of those cards are definitely not credit cards. While
debit cards and charge cards often share wallet space with their credit card cousins, each type of card is separate and distinct from its peers.
Credit Cards
True credit cards have a set spending limit ($500, $2,500, $25,000, etc.) based on the cardholder's
credit rating and current income. They enable consumers to carry a balance from month to month and charge interest on the outstanding debt.
In general, as you spend more money, your credit limit increases. If you chronically make late payments on your monthly bills or miss payments, your limit will be reduced (or your credit cut off), and the interest rate charged on the balance may be increased. (For further reading, see
Understanding Credit Card Interest.) While many credit cards are available with no annual fee, interest rates may run as high as 30%, so shop carefully when selecting a new card.
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If you have had trouble managing your credit and cannot obtain a credit card via the standard offerings, some credit card companies offer
secured cards. With such a card you deposit money with the card issuer - generally $300 to $500 - and then you can obtain a credit card with a spending limit equal to the amount of money deposited. The deposit earns interest and is generally refundable once you establish a satisfactory credit history.
Charge Cards
When you think about charge cards, think American Express. Unlike credit cards, charge cards do not have a monthly spending limit. You can make an unlimited number of purchases with your card, but you need to pay the balance in-full each month. Charge cards generally impose a fee and tack on penalties to discourage you from carrying a balance. Like credit cards, some charge cards impose a yearly fee. But regardless of fees, for many consumers the cost of having a charge card is often significantly lower than the cost of having a credit card due to the interest-related debt that can be racked up with the credit card.
Debit Cards
Debit cards work like plastic checks. When you make a purchase with a debit card, the payment for the purchase is taken directly from your bank account. If your account has insufficient funds to cover the expense, your card payment will be declined.
Debit cards come in two varieties, online and offline. Online cards function like ATM cards, requiring you to enter a personal identification number (PIN) to initiate the immediate transfer of funds from the your bank account to the merchant's bank account. In some countries, such as Canada, online debit cards are the only variety of debit cards that are accepted.
Offline cards do not require you to enter a PIN. Instead, when you make a purchase, you sign for it in the same way you do for traditional credit card purchases. Several days later, funds to cover the purchase are transferred from your bank to the merchant's bank. The distinction between online and offline cards is often blurred because most cards can be used in both online and offline capacities.
If you want to curb your spending and avoid the urge to buy stuff that you can't really afford, debit cards are the right choice. There are no monthly bills, no interest charges, and generally no fees to obtain a debit card from your local bank. Visa and MasterCard affiliates issue most debit cards, so merchants that accept Visa and MasterCard credit cards also accept the debit cards.
The Power and Perils of Plastic
Putting plastic in your wallet is a convenient way to avoid carrying cash while maintaining the ability to make purchases. And if you participate in the various perks programs offered by credit cards and charge cards, you can earn airline miles or a variety of other rewards for purchasing items that you would have bought anyway.
From a financial perspective, debit and charge cards are even-structured, so they pose little danger to your financial wellbeing. Their internal controls discourage or forbid carrying a balance, so the temptation to make purchases that you can't afford is minimized.
Credit cards, on the other hand, have served as the instrument of financial ruin for more than a few careless shoppers. Interest rates border on the obscene, and as minimum monthly payments can stretch out the payback period of a purchase for years, credit cards encourage consumers to live beyond their means. To avoid the potential pitfalls that accompany credit card use, be mindful of your spending habits, and keep in mind that being able to make the minimum monthly payment does not mean that you can afford to make the purchase: it simply means that if you buy that item, not only will you be put in debt, but the interest payments will increase the total cost of the item to well beyond the sticker price.
(For more on tips on personal finance, see
Seven Common Financial Mistakes.)
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