Are credit cards real money? Many people wonder this when they use plastic to pay for things.
Credit cards are not money. They are a way to borrow money from a bank or credit card company to make purchases. So, when you use a credit card, you’re promising to pay back what you spent.
Money is something that everyone accepts as payment right away. Cash and the balance in your checking account are money. But credit cards create debt, not real money in your hands.
You have to pay off your credit card bill or the bank will charge you interest.
About credit cards
Credit cards are powerful financial tools that let you borrow money and make purchases. They offer convenience and flexibility, but also come with responsibilities.
Let’s explore how credit cards work and their key features.
Credit cards as a form of borrowing
Credit cards give you a way to borrow money for purchases. When you use a credit card, you’re not spending your own cash. Instead, you’re borrowing from the card issuer.
Here’s how it works:
- You make a purchase with your card
- The card issuer pays the merchant
- You owe that amount to the issuer
You then have a grace period, usually around 21-25 days, to pay back what you borrowed. If you pay the full amount, you won’t owe interest. But if you only pay part of it, you’ll be charged interest on the remaining balance.
Most Kenyan issuers though don’t offer such a grace period.
Credit cards are different from debit cards. Debit cards use money from your bank account. Credit cards let you borrow money up to a set limit.
They however work in a manner similar to overdraft products such as Fuliza
Credit limit and line of credit
Your credit card comes with a credit limit. This is the maximum amount you can borrow at one time. The limit is based on factors like your income and credit score.
A credit card is a type of revolving credit. This means:
- You can borrow up to your limit
- As you pay it back, you can borrow again
- You don’t need to reapply each time you want to use it
Your available credit goes down as you make purchases. It goes back up as you make payments. This flexibility lets you manage your spending and borrowing as needed.
Card issuers may increase your limit over time if you use the card responsibly. They might also lower it if you miss payments or your credit score drops.
Security features of credit cards
Credit cards have several security measures to protect you and your money:
- Chip technology: Embedded chips make cards harder to counterfeit
- Fraud monitoring: Issuers watch for unusual activity on your account
- Zero liability: You’re not responsible for unauthorized charges if you report them promptly
Many cards also offer:
- Virtual card numbers for safer online shopping
- The ability to freeze your card if it’s lost or stolen
- Alerts for large purchases or suspicious activity
These features help keep your account safe from fraud and theft. But it’s still important to use your card carefully and check your statements regularly.
Comparing cash and credit cards as Money
Cash and credit cards serve different roles in our financial system. They have distinct legal definitions, economic impacts, and practical uses.
Legal definitions of money
Cash is the most basic form of money. It includes physical coins and paper bills issued by the government. The Kenyan Shilling or US dollar is legal tender, which means it must be accepted for all debts and payments.
Credit cards are not legally defined as money. They’re a payment method that lets you borrow funds from a bank. When you use a credit card, you’re promising to pay the bank back later.
Credit card transactions often trigger fees, making them more expensive than cash for some payments. This affects their use as a money substitute.
Credit cards in the money supply
Economists track different measures of the money supply. These include:
- M1: Cash and checking accounts
- M2: M1 plus savings accounts and money market funds
- M3: M2 plus large time deposits and institutional money funds
Credit card balances are not part of these measures. But they do impact the broader financial system.
When you use a credit card, it can increase the money supply indirectly. Banks create new money when they lend, including through credit cards. This affects monetary policy and inflation.
Liquidity and accessibility
Cash is the most liquid form of money. You can use it instantly without any extra steps.
Credit cards offer high liquidityLiquidity refers to the ease with which assets can be converted into cash without significantly affecting their market price. This concept is crucial ... ... too, but with some limits:
- Spending caps
- Merchant acceptance
- Need for authorization
Credit cards provide easier access to large amounts of money than carrying cash. This can be helpful for big purchases or emergencies.
Credit Cards, banks, and the economy
Credit cards play a big role in how we spend money and how banks work. They affect the economy in many ways.
Role in consumer spending
Credit cards make it easy to buy things. You can use them for small and big purchases. This boosts spending in stores and online.
Credit cards also offer rewards like cash back or points. This can make people spend more than they planned. It’s good for stores but can lead to debt if you’re not careful.
Impact on credit and debt cycles
Credit cards can help or hurt your credit score. If you pay on time, it looks good. But if you miss payments, your score drops.
Many people use credit cards for big costs they can’t pay right away. This creates a cycle of debt. You might pay only the minimum each month. This means you owe more in interest over time.
Banks make money from credit card interest and fees. When lots of people use credit cards, it affects how much money is moving through the economy.
Credit cards and the Central Bank
The Central Bank of Kenya closely monitors credit card usage as it provides insights into consumer spending and debt levels.
An increase in credit card debt can indicate a strong economy, but excessive debt poses risks. To manage borrowing, the Central Bank may adjust interest rates accordingly.
Although credit cards are not counted as part of the money supply, they influence the flow of money, impacting the Central Bank’s economic decisions.
Practical aspects of credit card use
Credit cards offer convenience and benefits, but they require careful management. You need to understand how they work and use them wisely to avoid debt and build good credit.
Understanding rewards, fees, and charges
Credit cards often come with rewards programs. These can include cash back, miles, or points on purchases. Some cards offer sign-up bonuses for new users.
But watch out for fees. Many cards charge an annual fee. This can range from KES 3,000 to 7,000. Other fees to know about:
- Late payment fees
- Balance transfer fees
- Foreign transaction fees
Interest charges are a big cost of credit cards. The APR (annual percentage rate) tells you how much interest you’ll pay on unpaid balances. APRs can be high, often 15-25%.
To avoid interest, pay your full balance each month. If you can’t, always pay more than the minimum due.
Managing credit card debt
Credit card debt can grow fast if not managed well. Here are tips to keep it under control:
- Track your spending closely
- Set a budget and stick to it
- Consider a balance transfer to a lower-interest card
Paying off your balance in full each month is ideal. This minimizes interest charges and keeps your credit utilization low.
Building a good credit history
Credit cards can help build your credit score if used responsibly. Here’s how:
- Make all payments on time
- Keep your credit utilization low (under 30% of your limit)
- Maintain long-standing accounts
- Mix different types of credit
On-time payments are crucial. You should set up automatic payments to avoid late fees and credit score damage.
Your credit score affects many areas of your life. It can impact your ability to get loans, rent apartments, or even land certain jobs. Using credit cards wisely is an easy way to build a strong credit history.
