According to data released in 2014 by the Federal Reserve Bank of Boston, in 2012, the average American credit card holder had four credit cards, including 2.4 general purpose cards, 1.5 merchant-branded cards, and 0.2 charge cards. The first two types are relatively common, but the third—charge cards—may raise questions for some consumers. Just how do charge cards work, and how do you decide if they are right for you?
How traditional credit cards work
To understand how a charge card differs from a credit card, you must first understand how a credit card works. You can use a credit card to make purchases for which you are billed later, usually at the end of a 30-day billing cycle. If you do not pay off your debt by the end of the billing cycle, traditional credit card agreements allow you to carry the debt into the next billing cycle with additional interest fees tacked onto the total balance. For this reason, credit cards are commonly known as “revolving” accounts. Typically, you are billed only for a percentage of the total balance (your minimum payment), so it’s easy to carry a balance from month to month.
Traditional credit cards also have a credit limit, which determines how much you are able to charge. The credit limit you are offered can differ based on the lender’s policies. Some credit card issuers use a customer’s credit score and borrowing history to determine a credit limit, whereas others simply set standard limits for each credit card.
Credit limits on traditional credit cards play an important role in your credit score because they help determine your credit utilization ratio, which compares the amount of credit you use to the amount of credit available to you. Maxing out your credit card, or using 100 percent of your available credit, can reflect negatively on your borrowing history. Your credit utilization ratio accounts for about 30 percent of your credit score.
How charge cards differ from traditional credit cards
Charge cards also allow you to make payments for which you are billed later. However, the main differences between traditional credit cards and charge cards are that charge cards may not allow you to carry a balance from month to month and they do not have interest rates or minimum payments. Instead, the full balance on the card is due at the end of the 30-day billing cycle. If you do not pay the full balance, you could incur penalty fees and your account could be suspended.
Unlike traditional credit cards, most charge cards do not have a credit limit, so you can use them to pay for large purchases. Your purchases are approved based on your payment history, income, and credit score.
Because charge cards do not carry credit limits, racking up a large balance on a charge card may not negatively impact your borrowing history.
Equifax credit scores range from 280 to 850, and you generally need a very good or excellent credit score (between 725 and 850 on Equifax’s credit score scale) to qualify for a charge card. This is not always the case with traditional credit cards, although you may pay higher interest fees if you have a poor credit score.
Additional pros and cons of charge cards
Most charge cards carry an annual fee and, similar to many traditional credit cards, offer rewards such as travel discounts and cash-back incentives. The annual fees for charge cards are often much higher than for credit cards, but the charge card memberships often have better rewards, such as travel bonuses and transferable points that can be used in grocery stores and gas stations.
People who travel often or who want to use their points flexibly may find that charge cards offer some of the best membership benefits. Businesses also often use charge cards because of the travel perks and the ability to keep track of employee expenses.
If you are interested in trying a charge card, you should thoroughly review the terms and conditions. Know what your annual fee will be as well as your membership benefits. And be careful not to miss your monthly payment—you could face a fine of as much as 3 percent of your balance.
Diane Moogalian is vice president of operations for Equifax Personal Solutions. Prior to joining Equifax in 2007, Diane held several strategic roles with leading financial services companies. Diane graduated from the University of Richmond with a Bachelor of Science in Business Administration (Marketing and Economics) and earned a Certificate in International Business from Virginia Commonwealth University.
The information contained in this blog post is designed to generally educate and inform visitors to the Equifax Finance Blog. The blog posts do not give, and should not be assumed to provide, personalized tax, investment, real estate, legal, retirement, credit, personal financial, or other professional advice. Before making any financial decision, you should always consult with the appropriate professionals who can explain your options, rights, and legal responsibilities, and advise you on any tax, legal, credit, or business implications that may result from those decisions. The views and opinions expressed by the authors of blog posts are their own views and may not be the views or opinions of Equifax, Inc. and/or its affiliates.