Credit Cards

I. Credit cards – general

A credit card is a system of payment named after the small plastic card issued to users of the system. A credit card is different from a debit card in that it does not remove money from the user's account after every transaction. In the case of credit cards, the issuer lends money to the consumer (or the user). It is also different from a charge card (though this name is sometimes used by the public to describe credit cards), which requires the balance to be paid in full each month. In contrast, a credit card allows the consumer to 'revolve' their balance, at the cost of having interest charged. Most credit cards are the same shape and size, as specified by the ISO 7810 standard.

For the user is issued a credit card after an account has been approved by the credit provider with which the user will be able to make purchases from merchants accepting that credit card up to a pre- established credit limit.

When a purchase is made, the credit card user agrees to pay the card issuer. The cardholder indicates their consent to pay, by signing a receipt with a record of the card details and indicating the amount to be paid or by entering a PIN.

Electronic verification systems allow merchants to verify that the card is valid and the credit card customer has sufficient credit to cover the purchase in a few seconds, allowing the verification to happen at time of purchase. The verification is performed using a credit card payment terminal or Point of Sale (POS) system with a communications link to the merchant's acquiring bank.

Each month, the credit card user is sent a statement indicating the purchases undertaken with the card, any outstanding fees, and the total amount owed.

Credit card issuers usually waive interest charges if the balance is paid in full each month, but typically will charge full interest on the entire outstanding balance from the date of each purchase if the total balance is not paid.

For example, if a user had a $1,000 outstanding balance and pays it in full, there would be no interest charged. If, however, even $1.00 of the total balance remained unpaid, interest would be charged on the full $1,000 from the date of purchase until the payment is received. The precise manner in which interest is charged is usually detailed in a cardholder agreement which may be summarized on the back of the monthly statement. The general calculation formula most financial institutions use to determine the amount of interest to be charged is APR/100xADB/365xnumber of days revolved. Take the Annual percentage rate (APR) and divide by 100 then multiply to the amount of the average daily balance divided by 365 and then take this total and multiply by the total number of days the amount revolved before payment was made on the account.

Interest rates can vary considerably from card to card, and the interest rate on a particular card may jump dramatically if the card user is late with a payment on that card or any other credit instrument, or even if the issuing bank decides to raise its revenue.

Because of intense competition in the credit card industry, credit providers often offer incentives such as frequent flier points, gift certificates, or cash back (typically up to 1 percent based on total purchases) to try to attract customers to their program.

Low interest credit cards or even 0% interest credit cards are available. The only downside to consumers is that the period of low interest credit cards is limited to a fixed term, usually between 6 and 12 months after which a higher rate is charged. However, services are available which alert credit card holders when their low interest period is due to expire. Most such services charge a monthly or annual fee.

II. Grace period

A credit card's grace period is the time the customer has to pay the balance, before interest is charged to the balance. Grace periods vary, but usually range from 10 to 55 days depending on the type of credit card and the issuing bank.

The merchant's side

An example of street markets accepting credit cards

For merchants, a credit card transaction is often more secure than other forms of payment, such as cheques, because the issuing bank commits to pay the merchant the moment the transaction is verified. The bank charges a commission (discount fee), to the merchant for this service and there may be a certain delay before the agreed payment is received by the merchant. In addition, a merchant may be penalized or have their ability to receive payment using that credit card restricted if there are too many cancellations or reversals of charges.

This process involves the following parties:

Cardholder: the owner of the card used to make a purchase

Merchant: the business accepting credit card payments for products or services sold to the cardholder

Acquirer: the financial institution or other organization that provides card processing services to the merchant

Card association: a network such as VISA® or MasterCard® (and others) that acts as a gateway between the acquirer and issuer for authorizing and funding transactions

Issuer: the financial institution or other organization that issued the credit card to the cardholder

Authorization

The cardholder pays for the purchase and the merchant submits the transaction to the acquirer. The acquirer verifies with the issuer—almost instantly—that the card number and transaction amount are both valid, and then processes the transaction for the cardholder.

Batching

After the transaction is authorized it is then stored in a batch, which the merchant sends to the acquirer later to receive payment (usually at the end of the day).

Clearing and settlement

The acquirer sends the transactions in the batch through the card association, which debits the issuers for payment and credits the acquirer. In effect, the issuers pay the acquirer for the transactions.

Funding

Once the acquirer has been paid, the merchant receives payment. The amount the merchant receives is equal to the transaction amount minus the discount rate, which is the fee the merchant pays the acquirer for processing the transaction.