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ADVISORY COLUMN: PERSONAL FINANCIAL ADVISER

Oran Hall | Understanding how credit cards work

Published:Sunday | November 28, 2021 | 12:07 AM

Apart from the convenience, there are advantages to using credit cards.

People who pay in full and on time may consider that they do get free short-term credit.

Users of some cards may benefit from discounts from some providers of goods and services and frequent-flyer miles may be earned for international travel in some cases.

Cardholders may also use them to rent and lease goods and services from people and businesses who honour them and to do online shopping. This makes it quite easy to purchase goods and services from other countries. Additionally, they may be used to get cash advances (loans) from financial institutions that accept them.

The credit cardholder may designate other people to use the account. In such cases, the additional users are issued supplementary cards. Although this can be beneficial to a family, for example, it has the associated risk of a cardholder exposing others on the account to high-debt levels and possibly a compromised credit rating.

Each credit card account has a credit limit. The total amount of credit outstanding at any point, inclusive of charges, should not exceed this limit. When this is facilitated, there are associated charges such as additional interest and possibly over limit fees.

In cases in which there is more than one person on the account, they are jointly and individually liable for the liabilities outstanding on the account.

When cardholders use their cards to purchase goods and services and pay government charges or to get cash advances, they are committing to repay the full amount and any interest and other charges. There is a set date by which the full amount should be paid, but payment may be made on, or before that date.

Failure to pay in full for a cycle attracts interest on the entire amount and it is added to the account on the next statement. Thus, paying the minimum balance indicated by the issuer of the card, or even paying a very substantial portion of the amount due attracts interest on the full amount for that cycle.

Interest is generally computed on the average daily balance. It is arrived at by totalling the beginning balance for each day in the billing period and then subtracting any credits to the account that day. The resulting daily balances are added and the total is divided by the number of days in the cycle.

The minimum payment indicated by the financial institution on each monthly statement is a percentage of the current balance, plus any past due amount. Account holders who are in excess of their limit are required to pay the excess portion in full, plus a percentage of the limit.

Each statement covers a particular cycle. A cycle may end on the 10th of the month, for example. The following cycle would, therefore, commence on the 11th of the month. A statement would thus cover all charges for the period, beginning on the 11th of one month and ending on the 10th of the following month. When payments are made, they are applied to the oldest charges first.

There are several cases in which the financial institution which issues the card may require that immediate payment of balances should be made. For example, if the customer fails to make all required payments by the payment date, if the outstanding balance at any time exceeds the credit limit and if the customer fails to abide by any other terms of the cardholder agreement.

If the cardholder fails to comply with the request of the issuer for full payment of outstanding balances on the account, the financial institution may use the services of a debt collector, an attorney-at-law, or both, to obtain payment. The cost of these services becomes the expense of the cardholder and is added to the debt.

Credit card debt does not die with the cardholder, as the issuer may freeze the account and require immediate payment from the estate of all sums owing. If there is more than one cardholder and one dies, the other cardholder is liable for balances on the account.

Cardholders who default on their agreement with the issuer risk their account being terminated, the financial institution demanding immediate payment or fixing a minimum payment at the existing or a new percentage of the outstanding balance at the time of the default, or a specified dollar amount, which may be greater than the amount previously in effect, or the issuer requesting that the cardholder cut the card and return it.

The financial institution may also suspend or terminate the right of the cardholder to use the card to obtain credit without notice to the customer for any reason, but, if the customer is in good standing, it will give notice. It may also, in its own discretion, refuse to approve a transaction, thus limiting the ability of the cardholder to use the card.

In addition to the fees I mentioned previously, cardholders are required to pay annual membership fees, whether or not the card is used, and fees for the replacement of lost cards.

Considering the devastating effect credit cards can have on credit scores, they should be used responsibly.

Oran A. Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel.finviser.jm@gmail.com