What Credit Means to Us

Credit cards are certainly making a great many headlines in the news these days. First it was the Federal Reserve, then Congress and now President Obama are all weighing in on credit card reform. We have written many posts on the subject so please feel free to check some of the prior entries if you would like to learn the details of the proposed reforms.

For this post I would like to make mention of something that we never really dissect or talk about, perhaps because we just assume that everyone understands it. What I’m talking about here is exactly what is credit and how does it work. And more specifically, for our purposes, how it works in context with credit cards.

The word credit is derived from a Latin word and it means “to trust”. And in its simplest form that is exactly what credit is. When credit is extended to you it means that someone is trusting you to repay them their money.

Of course, the reason they are willing to lend you their money is because in addition to receiving the principle back in repayment, the lender also receives interest on the principle.

It is the interest on the principle that makes it enticing for the lenders to loan their money. Profit, pure and simple is the engine that drives the credit markets.

Credit cards were probably the first line of credit extended to you. For the vast majority of Americans that is the case. When we use our credit cards we are basically taking a loan from the bank or credit card issuer.

The credit card companies then make their profits from the interest and fees charged on the loans given. The banks and credit card issuers profit very handsomely from this endeavor.

In our next post we will discuss the advantages and disadvantages of using credit cards.