How credit cards work
A credit card is a plastic card that lets you access the credit card your credit card issuer gives you. A credit limit is like a loan. However, instead of giving you the full loan in cash, the bank lets you take as much of the credit as you want at a time and allows you to reuse the loan over and over as long as you pay back what you’ve borrowed.
How much credit card cost you as card holder
For a credit cardholder:
When you apply for a credit card, the card provider will check if you are financially eligible to own it or not. If you are eligible, then based on the amount you earn, the bank or Credit Card Company will set a credit limit for you.
Once you receive your credit card, you can use it to make payments on credit. By using this card, you are borrowing money from your card provider (Credit Card Company or bank). Every billing cycle you can use either the full credit limit or a portion of it. If you exceed your credit limit, you will have to pay a penalty.
At the end of every billing cycle, the lender expects you to repay the amount you have borrowed. There is a fixed interest free credit period, within which the cardholder is supposed to pay either the full amount due or a part of it. Credit card providers generally specify the minimum amount that cardholders have to pay every billing cycle, to avoid being considered a defaulter.
If the cardholders pay the full amount due, they do not have to pay any interest on their card. In case they pay only the minimum amount due or do not repay any money, then they will have to pay an interest on the outstanding balance and on the new purchases. The card provider will keep charging the interest until they pay the full outstanding balance.
There’s always a cost associated with borrowing money and you want to make sure these costs don’t take you by surprise. Knowing the cost of a credit card helps you decide whether you actually want to use a credit card or stick to another payment method.
For the other parties:
The other parties involved in the credit card system are:
- Merchants or sellers – They use the POS (Point of Sale) Terminals to swipe the credit cards of the customers to get their money.
- Payment Gateway – It is the online version of the POS machines used at retail outlets. The payment gateway authorises the purchases that are made using a credit card online.
- Credit Card Issuers – These are the banks or Credit Card Companies that offer credit cards, collect the monthly bills and deal with the customers.
- The Acquirer – It is the bank or financial institution that process the credit card payments on behalf of the merchants. The Acquirers provide the POS machines to the merchants.
- Association or Network – It refers to the payment processing network, which collect information from the processors, authorizes and collects the payments for the purchases, etc. For example – Visa, MasterCard, American Express, etc.
- Payment Processors – The payment processors take care of collecting the data and sending it to the Network. The right network is identified by the first and last digits of the credit card numbers.
When a cardholder swipes his/her credit card to make payment at a merchant outlet, a request is submitted by the merchant to the acquirer via a phone or network connection. The acquirer forwards this request to the card issuer to authorize the transaction. The card issuer has to check if the cardholder has enough credit available in his/her account to make the purchase. If yes, then an authorization code is sent by the issuer to the acquirer, who then approves the transaction and the purchase is made.
A merchant does not swipe just one card on the POS machine in a day. Depending on the number of customers, there can be many requests sent by the merchant to the acquirer. So, in order to track the sales, merchants send the requests to the acquirer in batches through the card association or network to the issuers to get the payment. The association distributes the transactions according to the issuers. The issuers deduct the interchange fee and transfers the amount to the acquirer, who after deducting their share, sends the balance to the merchants. The transaction rates varies from merchant to merchant and is dependent on the transaction numbers, type, category, etc. The payment process is same in case of online purchases as well except that the payment are processed by payment gateways such as PayUMoney, VeriSign, etc.