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Credit Card

What is a Credit Card?

A credit card is a plastic payment card issued to users (cardholders). It enables the cardholder to pay a merchant for goods and services based on his promise to the card issuer to pay them for the amounts plus other agreed charges. The card issuer (usually a bank) creates a revolving account and grants a line of credit to the cardholder, from which the cardholder can borrow money for payment to a merchant or as a cash advance.

Technical Specifications

The size of most credit cards is 85.60 mm x 53.98 mm and rounded corners with a radius of 2.88-3.48 mm. The size of most credit cards is the same as the size of ATM cards and other payment cards, such as debit cards.

Credit cards have a printed or embossed bank card number. The first six digits, called the Bank Identification Number, determine the bank to which the credit card number belongs. The next nine digits are the individual account number, and the final digit is a validity check code. Credit cards have a magnetic stripe conforming to the ISO/IEC 7813. Many modern credit cards have a computer chip embedded in them as a security feature.

In addition to the main credit card number, credit cards also carry issue and expiration dates (given to the nearest month), as well as extra codes such as issue numbers and security codes. Not all credit cards have the same sets of extra codes nor do they use the same number of digits.

Features

  • A convenient credit
  • Credit cards offer consumers an easy way to track expenses, which is necessary for both monitoring personal expenditures and the tracking of work-related expenses for taxation and reimbursement purposes. Credit cards are accepted in larger establishments in almost all countries, and are available with a variety of credit limits, repayment arrangements. Some have added perks (such as insurance protection, rewards schemes in which points earned by purchasing goods with the card can be redeemed for further goods and services or cashback).

Usage

A credit card issuing company, such as a bank or credit union, enters into agreements with merchants for them to accept their credit cards. Merchants often advertise which cards they accept by displaying acceptance marks - generally derived from logos - or this may be communicated in signage in the establishment or in company material (e.g., a restaurant's menu may indicate which credit cards are accepted). Merchants may also communicate this orally, as in "We take (brands X, Y, and Z)" or "We don't take credit cards".

Visa, MasterCard, American Express are card-issuing entities that set transaction terms for merchants, card-issuing banks, and acquiring banks.

The credit card issuer issues a credit card to a customer at the time or after an account has been approved by the credit provider, which need not be the same entity as the card issuer. The cardholders can then use it to make purchases at merchants accepting that card. When a purchase is made, the cardholder agrees to pay the card issuer. The cardholder indicates 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 personal identification number (PIN). Also, many merchants now accept verbal authorizations via telephone and electronic authorization using the Internet, known as a card not present transaction (CNP).

Electronic verification systems allow merchants to verify in a few seconds that the card is valid and the cardholder has sufficient credit to cover the purchase, allowing the verification to happen at the 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. Data from the card is obtained from a magnetic stripe or chip on the card.

For card not present transactions where the card is not shown (e.g., e-commerce, mail order, and telephone sales), merchants additionally verify that the customer is in physical possession of the card and is the authorized user by asking for additional information such as the security code printed on the back of the card, date of expiry, and billing address.

Each month, the cardholder is sent a statement indicating the purchases made with the card, any outstanding fees, and the total amount owed. After receiving the statement, the cardholder must pay a defined minimum portion of the amount owed by a due date, or may choose to pay a higher amount. The credit issuer charges interest on the unpaid balance if the billed amount is not paid in full (typically at a much higher rate than most other forms of debt). In addition, if the cardholder fails to make at least the minimum payment by the due date, the issuer may impose a late fee or other penalties. To help mitigate this, some financial institutions can arrange for automatic payments to be deducted from the cardholder's bank account, thus avoiding such penalties altogether, as long as the cardholder has sufficient funds.

Interest Charge

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.

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 / 100 x ADB )/ 365 x number of days revolved before payment was made on the account
Where

APR (Annual Percentage Rate) is the interest rate for a whole year (annualized), rather than just a monthly fee/rate, as applied on a loan, mortgage loan, credit card, etc. It is a finance charge expressed as an annual rate.

ADB stands for Average Daily Balance.

Financial institutions refer to interest charged back to the original time of the transaction and up to the time a payment was made, if not in full, as a residual retail finance charge (RRFC). Thus after an amount has revolved and a payment has been made, the user of the card will still receive interest charges on their statement after paying the next statement in full (in fact the statement may only have a charge for interest that collected up until the date the full balance was paid, i.e. when the balance stopped revolving).

The credit card may simply serve as a form of revolving credit, or it may become a complicated financial instrument with multiple balance segments each at a different interest rate, possibly with a single umbrella credit limit, or with separate credit limits applicable to the various balance segments. Usually, this compartmentalization is the result of special incentive offers from the issuing bank, to encourage balance transfers from cards of other issuers. In the event that several interest rates apply to various balance segments, payment allocation is generally at the discretion of the issuing bank, and payments will therefore usually be allocated towards the lowest rate balances until paid in full before any money is paid towards higher rate balances. 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.

Grace Period

A credit card's grace period is the time the cardholder has to pay the balance before interest is assessed on the outstanding balance. Grace periods may vary but usually range from 20 to 55 days depending on the type of credit card and the issuing bank.

Usually, if a cardholder is late paying the balance, finance charges will be calculated and the grace period does not apply. Finance charges incurred depend on the grace period and balance. With most credit cards there is no grace period if there is any outstanding balance from the previous billing cycle or statement (i.e. interest is applied on both the previous balance and new transactions). However, there are some credit cards that will only apply finance charge on the previous or old balance, excluding new transactions.

Types of Credit Card

  • Business credit cards - Business credit cards are specialized credit cards issued in the name of a registered business, and typically they can only be used for business purposes.

    Business credit cards offer a number of features specific to businesses. They frequently offer special rewards in areas such as shipping, office supplies, travel, and business technology. Most issuers use the applicant's personal credit score when evaluating these applications. In addition, income from a variety of sources may be used to qualify, which means these cards may be available to businesses that are newly established. In addition, most major issuers of these cards do not report account activity to the owner's personal credit unless there is a default. This may have the effect of protecting the owner's personal credit from the activity of the business.

  • Secured credit cards - A secured credit card is a type of credit card secured by a deposit account owned by the cardholder. Typically, the cardholder must deposit between 100% and 200% of the total amount of credit desired.

    The cardholder of a secured credit card is still expected to make regular payments, as with a regular credit card, but should they default on a payment, the card issuer has the option of recovering the cost of the purchases paid to the merchants out of the deposit. The advantage of the secured card for an individual with negative or no credit history is that most companies report regularly to the major credit bureaus. This allows building a positive credit history.

    Secured credit cards are an option to allow a person with a poor credit history or no credit history to have a credit card which might not otherwise be available. They are often offered as a means of rebuilding one's credit. Fees and service charges for secured credit cards often exceed those charged for ordinary non-secured credit cards. For people in certain situations, (for example, after charging off on other credit cards, or people with a long history of delinquency on various forms of debt), secured cards are almost always more expensive than unsecured credit cards.

  • Prepaid cards - A "prepaid credit card" is not a true credit card, since no credit is offered by the card issuer. The cardholder spends money which has been "stored" via a prior deposit by the cardholder or someone else, such as a parent or employer. However, it carries a credit-card brand (such as Discover, Visa, MasterCard, American Express etc.) and can be used in similar ways just as though it were a credit card. Unlike debit cards, prepaid credit cards generally do not require a PIN. An exception is prepaid credit cards with an EMV chip. These cards do require a PIN if the payment is processed via Chip and PIN technology.
  • Digital cards - A digital card, virtual card or cloud card is an online hosted, digital virtual representation of any plastic card or a generic identification method. A digital card, unlike a plastic card, doesn't require any physical representation in the first place as it is fully virtual and hosted online. A digital card can emulate (imitate) any kind of plastic card but is mostly used with a credit card, loyalty card, health insurance card, driver's license, Social Security number, etc.

Benefits and Drawbacks

Benefits to cardholder

  • The main benefit to the cardholder is convenience. Compared to debit cards and checks, a credit card allows small short-term loans to be quickly made to a cardholder who need not calculate a balance remaining before every transaction, provided the total charges do not exceed the maximum credit line for the card.
  • Many credit cards offer rewards and benefits packages, such as enhanced product warranties at no cost, free loss/damage coverage on new purchases, various insurance protections, for example, rental car insurance, common carrier accident protection, and travel medical insurance.
  • Credit cards can also offer a loyalty program, where each purchase is rewarded with points, which may be redeemed for cash or products. Research has examined whether competition among card networks may potentially make payment rewards too generous, causing higher prices among merchants, thus actually impacting social welfare and its distribution, a situation potentially warranting public policy interventions.
  • Rewards - Many credit card customers receive rewards, such as frequent flyer points, gift certificates, or cash back as an incentive to use the card. Rewards are generally tied to purchasing an item or service on the card, which may or may not include balance transfers, cash advances, or other special uses.

Drawbacks to cardholders

  • High interest and bankruptcy - Low introductory credit card rates are limited to a fixed term, usually between 6 and 12 months, after which a higher rate is charged. As all credit cards charge fees and interest, some customers become so indebted to their credit card provider that they are driven to bankruptcy. Some credit cards often levy a rate of 20 to 30 per cent after a payment is missed.
  • Weakens self regulation -Several studies have shown that consumers are likely to spend more money when they pay by credit card. Researchers suggest that when people pay using credit cards, they do not experience the abstract pain of payment. Furthermore, researchers have found that using credit cards can increase the consumption of unhealthy food.

Benefits to merchants

  • 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 authorized, regardless of whether the consumer defaults on the credit card payment. In most cases, cards are even more secure than cash, because they discourage theft by the merchant's employees and reduce the amount of cash on the premises. Finally, credit cards reduce the back office expense of processing checks/cash and transporting them to the bank.
  • Prior to credit cards, each merchant had to evaluate each customer's credit history before extending credit. That task is now performed by the banks which assume the credit risk. Credit cards can also aid in securing a sale especially if the customer does not have enough cash on hand or in a checking account. Extra turnover is generated by the fact that the customer can purchase goods and services immediately and is less inhibited by the amount of cash in pocket and the immediate state of the customer's bank balance. Much of merchants' marketing is based on this immediacy.

Costs to Merchants

  • Merchants are charged several fees for accepting credit cards. The merchant is usually charged a commission of around 1 to 4 per cent of the value of each transaction paid for by credit card. The merchant may also pay a variable charge, called a merchant discount rate, for each transaction. In some instances of very low-value transactions, use of credit cards will significantly reduce the profit margin or cause the merchant to lose money on the transaction. Merchants with very low average transaction prices or very high average transaction prices are more averse to accepting credit cards. In some cases, merchants may charge users a "credit card supplement" (or surcharge), either a fixed amount or a percentage, for payment by credit card. Most retailers have not started using credit card surcharges, however, for fear of losing customers.
  • Merchants are also required to lease or purchase processing equipment, in some cases, this equipment is provided free of charge by the processor. Merchants must also satisfy data security compliance standards which are highly technical and complicated. In many cases, there is a delay of several days before funds are deposited into a merchant's bank account. Because credit card fee structures are very complicated, smaller merchants are at a disadvantage to analyze and predict fees.

Security

Credit card security relies on the physical security of the plastic card as well as the privacy of the credit card number. Therefore, whenever a person other than the card owner has access to the card or its number, security is potentially compromised. Once, merchants would often accept credit card numbers without additional verification for mail order purchases. It's now common practice to only ship to confirmed addresses as a security measure to minimise fraudulent purchases. Some merchants will accept a credit card number for in-store purchases, whereupon access to the number allows easy fraud, but many require the card itself to be present and require a signature (for magnetic stripe cards). A lost or stolen card can be cancelled, and if this is done quickly, will greatly limit the fraud that can take place in this way.

Source : WIKIPEDIA

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Modified : June 03, 2019