What is a Credit Card and How IT Works?

Recently, there were lots of news regarding the misuse of Credit Cards. We all are using Credit Cards while shopping and use it for online purchases. Have you ever thought of how the merchant is getting the money from the Credit Card transactions? This article explains in simple words, what is a Credit Card and in what way it is useful to you.

What is a Credit Card? 

Credit Cards also known as plastic money allows you to postpone your cash outgo whenever you make a purchase using the Credit Card. It allows you to purchase goods up to a fixed limit, based on your commitment to pay the amount plus an interest to the issuing bank, if the payment is not done in time. It is almost like buy now and pay later!

Credit Cards are issued by Banks based on the buying power of the individual. This is determined by the individual’s income and past credit history.

What is a credit cardBefore discussing, what is a Credit Card, let us understand certain common terms associated with a Credit Card. Mr. A is having a Citibank Platinum Card with a credit limit of Rs. 2 Lakhs. It carries a Master Card logo.

  1. Issuing Bank: This is the bank issuing your Credit Card. In the above example, it is CitiBank.
  2. Acquiring Bank: This is the bank with which the merchant is having a business relationship. It receives all Credit Card transactions from the merchant. The name of this bank will be displayed on the swipe machine with the merchant.
  3. Credit Card Companies: Worldwide, the leaders in this business are Visa and Master Card. The other important players are American Express and Diners Club.

Now, let us see how a Credit Card works?

The following steps are involved in a Credit Card transaction:

  1. You make payment of your bill at a store using the Credit Card.
  2. The merchant swipes your Credit Card and enters the bill amount.
  3. While swiping, the machine captures your data from the magnetic tape on the back of the Credit Card.
  4. The transaction will be processed by the acquiring bank and it transmits the data to the card issuing bank.
  5. The issuing bank authorises the transaction after verifying your credit limit etc. and sends the confirmation to the acquiring bank.
  6. A credit slip is printed out by the Credit Card machine. The merchant will ask your signature. This makes you committed to make the card payments in future.
  7. At the close of the day, the merchant will transmit the data of all Credit Card transaction of the day to the acquiring bank.
  8.  The acquiring bank collects money from various card issuing banks and then pays it to the merchant.

How the banks will benefit in Credit Card transaction?

Don’t expect that the merchant will get the full amount from the bank. The 2 banks and the card issuing company will share around 2-3% of the bill amount. The merchant will get only the balance. That is why, some merchants will give you discount, if you pay by cash. Also, the bank will get huge interest, if you delay your dues.

When you have to pay the amount?

You will get your monthly bill from the card issuing bank after each billing cycle. The bill will mention the total amount due and the due date of payment.  They will also, give an option to pay a minimum amount due, if you cannot pay the full amount due on the due date.

What will happen, if you pay only the minimum amount due?

The balance amount will be charged a huge interest by the bank. The interest rates in this are very high as 3-4% per month. If you pay only the minimum amount due, then your further usage also will attract interest from the date of purchase. In effect, you will get into a Credit Card trap.

What are the advantages of using Credit Cards?

If you pay the full amount due before the due date, there is no interest payable. So, you will get a free credit from the date of purchase till the date of bill. In most cases, this free credit can go up to 40-50 days, depending on your billing cycle.

Have self control and manage it well for optimum results.

When you are spending using Credit Cards, there is a tendency to overspend, because you are paying at a later date. This is to be avoided. If you spend as per your requirements and use the Credit Card as a medium of payment, it is very useful. But if you want to use it to overspend, then you will land up in trouble. If you don’t pay the dues in time, your Cibil Score also will be affected. This can create problem, when you are applying for home loan etc in future.

Security Aspects

Don’t allow others to use your Credit Cards and don’t inform about the PIN number to others. Opt for Email alert and SMS alert in your mobile number, so that you will get confirmation as and when the card is used. In case, you find that your card is used by somebody, call the toll free number of the bank and deactivate your card immediately.

Hope, now you are clear on what is a Credit Card and how it works. It is like a nuclear power. If you use it for a good purpose, it will help you, otherwise, it is a weapon for your financial mess.

2 thoughts on “What is a Credit Card and How IT Works?”

  1. One query on the above article.
    If the credit card is issued by the respective banks, then what is role of Credit Card Companies like Visa, Mastercard, etc.
    Why cant the banks create their own credit card and give it to their customers ?

    1. The technology involved is complex which prevents more companies entering this business. Master cards, Visa, Diners cards etc are global leaders in this field with very less competition from new entrants.

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