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Credit cards)
A credit card is a system of payment named after the small plastic card issued to users of the system. In the case of credit cards, the issuer lends money to the consumer (or the user) to be paid later to the merchant. It is different from a charge card,
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 issued by local banks or credit unions, and are the same shape and size, as specified by the ISO 7810 standard.
How credit cards work
Credit cards are issued after an account has been approved by the
credit provider, after which cardholders can use it to make purchases
at merchants accepting that card.
When a purchase is made, the credit card user agrees to pay the card
issuer. The cardholder indicates his/her 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/Cardholder Not Present' (CNP) transaction.
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. Data from the card is obtained from a magnetic stripe or chip on the card; the latter system is in the United Kingdom and Ireland commonly known as Chip and PIN, but is more technically an EMV card.
Other variations of verification systems are used by eCommerce
merchants to determine if the user's account is valid and able to
accept the charge. These will typically involve the cardholder
providing additional information, such as the security code printed on the back of the card, or the address of the cardholder.
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. After receiving the statement, the cardholder may dispute
any charges that he or she thinks are incorrect (see Fair Credit Billing Act for details of the US regulations). Otherwise, the cardholder must pay a defined minimum proportion of the bill by a due date, or may choose to pay a higher amount up to the entire amount owed. The credit provider charges interest
on the amount owed (typically at a much higher rate than most other
forms of debt). Some financial institutions can arrange for automatic
payments to be deducted from the user's bank accounts, thus avoiding
late payment altogether as long as the cardholder has sufficient funds.
Interest charges
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 transaction and repaid it in
full within this grace period, there would be no interest charged. If,
however, even $1.00 of the total amount remained unpaid, interest would
be charged on the $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/100 x ADB/365 x number of days revolved. Take the Annual
percentage rate (APR) and divide by 100 then multiply to the amount of
the average daily balance (ADB) 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. 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 RRFC or residual retail
finance charge. 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).[1]
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.
Benefits
Because of intense competition in the credit card industry, credit card providers often offer incentives such as frequent flyer points, gift certificates, or cash back (typically up to 1 percent based on total purchases) to try to attract customers to their programs.
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.
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 20 to 30 days depending on the type of credit
card and the issuing bank. Some policies allow for reinstatement after
certain conditions are met.
Usually, if a customer 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.
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 checks, 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
(except for legitimate disputes, which are discussed below, and can
result in charges back to the merchant). 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. 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.
For each purchase, the bank charges the merchant a commission
(discount fee) for this service and there may be a certain delay before
the agreed payment is received by the merchant. The commission is often
a percentage of the transaction amount, plus a fixed fee. 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 as a result of disputes. Some small merchants
require credit purchases to have a minimum amount (usually between $5
and $10) to compensate for the transaction costs, though this is not
always allowed by the credit card consortium.
In some countries, for example the Nordic countries, banks guarantee payment on stolen cards only if an ID card
is checked and the ID card number/civic registration number is written
down on the receipt together with the signature. In these countries
merchants therefore usually ask for ID. Non-Nordic citizens, who are
unlikely to possess a Nordic ID card or driving license, will instead
have to show their passport, and the passport number will be written
down on the receipt, sometimes together with other information. Some
shops use the card's PIN for identification, and in that case showing
an ID card is not necessary.
Parties involved
- Cardholder: The holder of the card used to make a purchase; the consumer.
- Card-issuing bank: The financial institution or other organization
that issued the credit card to the cardholder. This bank bills the
consumer for repayment and bears the risk that the card is used
fraudulently. American Express and Discover were previously the only
card-issuing banks for their respective brands, but as of 2007, this is
no longer the case.
- Merchant: The individual or business accepting credit card payments for products or services sold to the cardholder
- Acquiring bank: The financial institution accepting payment for the products or services on behalf of the merchant.
- Independent sales organization: Resellers (to merchants) of the services of the acquiring bank.
- Merchant account:
This could refer to the acquiring bank or the independent sales
organization, but in general is the organization that the merchant
deals with.
- Credit Card association: An association of card-issuing banks such as Visa, MasterCard, Discover, American Express, etc. that set transaction terms for merchants, card-issuing banks, and acquiring banks.
- Transaction network: The system that implements the mechanics of
the electronic transactions. May be operated by an independent company,
and one company may operate multiple networks. Transaction processing
networks include: Cardnet, Nabanco, Omaha, Paymentech, NDC Atlanta,
Nova, Vital, Concord EFSnet, and VisaNet.[2]
- Affinity partner: Some institutions lend their names to an issuer
to attract customers that have a strong relationship with that
institution, and get paid a fee or a percentage of the balance for each
card issued using their name. Examples of typical affinity partners are
sports teams, universities and charities.
The flow of information and money between these parties — always
through the card associations — is known as the interchange, and it
consists of a few steps.
Transaction steps
- Authorization:
The cardholder pays for the purchase and the merchant submits the
transaction to the acquirer (acquiring bank). The acquirer verifies the
credit card number, the transaction type and the amount with the issuer
(Card-issuing bank) and reserves that amount of the cardholder's credit
limit for the merchant. An authorization will generate an approval
code, which the merchant stores with the transaction.
- Batching: Authorized transactions are stored in "batches",
which are sent to the acquirer. Batches are typically submitted once
per day at the end of the business day. If a transaction is not
submitted in the batch, the authorization will stay valid for a period
determined by the issuer, after which the held amount will be returned
back to the cardholder's available credit (see authorization hold).
Some transactions may be submitted in the batch without prior
authorizations; these are either transactions falling under the
merchant's floor limit
or ones where the authorization was unsuccessful but the merchant still
attempts to force the transaction through. (Such may be the case when
the cardholder is not present but owes the merchant additional money,
such as extending a hotel stay or car rental.)
- Clearing and Settlement: The acquirer sends the batch
transactions through the credit card association, which debits the
issuers for payment and credits the acquirer. Essentially, the issuer
pays the acquirer for the transaction.
- Funding: Once the acquirer has been paid, the acquirer pays
the merchant. The merchant receives the amount totaling the funds in
the batch minus the "discount rate," which is the fee the merchant pays
the acquirer for processing the transactions.
- Chargebacks: A chargeback is an event in which money in a
merchant account is held due to a dispute relating to the transaction.
Chargebacks are typically initiated by the cardholder. In the event of
a chargeback, the
issuer returns the transaction to the acquirer for resolution. The
acquirer then forwards the chargeback to the merchant, who must either
accept the chargeback or contest it.
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. Thus if the
cardholder puts down $1000, they will be given credit in the range of
$500–$1000. In some cases, credit card issuers will offer incentives
even on their secured card portfolios. In these cases, the deposit
required may be significantly less than the required credit limit, and
can be as low as 10% of the desired credit limit. This deposit is held
in a special savings account.
Credit card issuers offer this because they have noticed that
delinquencies were notably reduced when the customer perceives
something to lose if the balance is not repaid.
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 for building of positive credit history.
Although the deposit is in the hands of the credit card issuer as
security in the event of default by the consumer, the deposit will not
be debited simply for missing one or two payments. Usually the deposit
is only used as an offset when the account is closed, either at the
request of the customer or due to severe delinquency (150 to 180 days).
This means that an account which is less than 150 days delinquent will
continue to accrue interest and fees, and could result in a balance
which is much higher than the actual credit limit on the card. In these
cases the total debt may far exceed the original deposit and the
cardholder not only forfeits their deposit but is left with an
additional debt.
Most of these conditions are usually described in a cardholder
agreement which the cardholder signs when their account is opened.
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. Secured credit cards are available with both Visa and MasterCard logos
on them. Fees and service charges for secured credit cards often exceed
those charged for ordinary non-secured credit cards, however, 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 can often be less expensive in total cost
than unsecured credit cards, even including the security deposit.
Sometimes a credit card will be secured by the equity in the borrower's home.[3][4] This is called a home equity line of credit (HELOC).
Prepaid "credit" cards
- See also: Stored-value card
A prepaid credit card is not a credit card,[5]
since no credit is offered by the card issuer: the card-holder spends
money which has been "stored" via a prior deposit by the card-holder or
someone else, such as a parent or employer. However, it carries a
credit-card brand (Visa, MasterCard, American Express or Discover) and
can be used in similar ways just as though it were a regular credit
card.[5][6]
After purchasing the card, the cardholder loads it with any amount of money, up to the predetermined card limit [7]
and then uses the card to make purchases the same way as a typical
credit card. Prepaid cards can be issued to minors (above 13) since
there is no credit line involved. The main advantage over secured
credit cards (see above section) is that you are not required to come
up with $500 or more to open an account. [8]
With prepaid credit cards you are not charged any interest but you are
often charged a purchasing fee plus monthly fees after an arbitrary
time period. Many other fees also usually apply to a prepaid card.[5]
Prepaid credit cards are sometimes marketed to teenagers[5] for shopping online without having their parents complete the transaction.[9][10][11][12]
Because of the many fees that apply to obtaining and using credit-card-branded prepaid cards, the Financial Consumer Agency of Canada describes them as "an expensive way to spend your own money".[13] The agency publishes a booklet, "Pre-paid cards",[14] which explains the advantages and disadvantages of this type of prepaid card.
Features
As well as convenient, accessible 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 worldwide, and are available with a
large variety of credit limits, repayment arrangement, and other perks
(such as rewards schemes in which points earned by purchasing goods with the card can be redeemed for further goods and services or credit card cashback).
Some countries, such as the United States, the United Kingdom, and France, limit the amount for which a consumer can be held liable due to fraudulent transactions as a result of a consumer's credit card being lost or stolen.
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. Merchants often accept
credit card numbers without additional verification for mail order
purchases. They however record the delivery address 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. Thus, a stolen card can be cancelled,
and if this is done quickly, no fraud can take
Classical
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