Overview of Credit Cards

A credit card is an instrument issued by a financial institution, usually a bank, to an individual. The issuing authority, in effect, assures the individual that it will lend him a certain amount of money (equal to the card limit) to pay for his purchases.

All credit cards follow a standard size called ID-1, as defined under ISO/IEC 7810, which is 85.60 x 53.98 mm.

How do They Work

A credit card is very different from a debit card, because in such a transaction, money is not taken out of the cardholder’s bank account. It is simply reduced from the total amount that can be lent by the bank (which is the credit limit). Interest is charged on the total amount spent by the cardholder as per a ‘revolving credit’ method. The individual can then choose to either repay the entire amount due or pay a minimum amount, every billing cycle.

The terms and conditions, including the method of calculating the minimum amount due and the rate of interest, the amount of days after which the interest will be charged, etc. are mentioned in the contract or agreement between the individual and the card issuer.

Credit Card Transaction: The Process

Here are the sequential steps that follow when the individual wishes to pay by a credit card:

The cardholder provides his card to the merchant who swipes it on a payment terminal or a point-of-sale. This terminal communicates with the system of the issuing bank to ensure that the amount being swiped for, falls within the available credit limit. If yes, the transaction is authorized by the bank. The cardholder then signs on the receipt, which is his consent to the transaction, and obligation to pay the bank, the amount of the transaction.

Nowadays, some cards also incorporate an extra security measure wherein the cardholder has to type in his ‘Personal Identification Number’ or PIN after the card is swiped. Alternatively, if the individual is using his card over the Internet, he will enter in his card number and the 3-digit security code (which is present on the back of the card) into the website form. The website’s payment gateway then connects with the system of the issuing bank and confirms if the limit is available. If it is, the transaction goes through. These type of transactions are also called ‘card not present’ or CNP transactions.

Each month, the cardholder receives a statement which informs him of the transactions that have occurred and the charges that he has to pay, which include the total amount due, the minimum amount due, the amount of interest being charged, etc.

There are many ways in which the cardholder can make a payment; he can send in a check for the amount or make the payment over the Internet or telephone, depending upon the services provided by the issuing bank.

Popularity, Criticism, and Risks

Credit cards are quite popular and people often have multiple such cards with them. The idea of credit is essentially a good one for those people who like to purchase things, but may not have the cash available with them at that time. They can choose to repay the amount later, in a manner that suits them, either by repaying the entire amount or at least the minimum.

However, one should be aware that these card companies charge a very high interest rate for the service that they are providing. They have come under a lot of criticism for inducing people to take their cards, by offering them various incentives. Depending on the tendencies of the individual, having a credit card may often turn out to be a curse, rather than a boon. It has become quite common to come across people, who have several cards with high credit limits, and are now in severe debt due to careless spending.

Apart from the risk of overspending, these instruments are often at a risk of fraud. Nowadays, there are several unscrupulous people who collect card numbers (either by copying the details during an actual transaction, skimming the card, or by stealing them from the web databases). These fraudsters then make purchases on the card, the payment for which the cardholder has to bear.

This creates a lot of problems for the card issuing companies, as they have to spend time and resources to trace and verify the fraudulent activity, and then ensure that the customer does not have to bear the brunt for those transactions. This often takes some time, and meanwhile, the customer can get quite hassled about making payments.

A credit card is a useful tool in the hands of the consumer provided it is used judiciously. These cards have revolutionized the way we look at money and thereby, altered the spending habits of society.