A credit card is a system of payment that lets the cardholder to pay for products and services based on the promise to pay for them. The credit card is based on the revolving account created by the credit card issuing company in favor of the credit card holder. The credit card issuing company issues a line of credit to the credit card holder and the person can use this line of credit for obtaining cash advance or for the purpose of making the payment to a merchant.
A credit card is different from other types of cards such as charge card or cash card. A charge card lets the holder make payments out of the balance existing on the card. Such card also requires the full payment of the balance each month. Credit cards are opposite to charge cards as these cards let the users enjoy continuous line of debt, subject to the constraints of interest. A cash card can be used as currency by its holder and it does not provide other services like credit card does.
Credit cards have interesting history behind them. Modern credit cards were first used in 1920s. During this time, the cards were used for purpose of selling fuels to automobile owners. By 1938, several companies had started using the credit cards for business purpose. The Diners Club introduced the first general purpose card and in 1958, American Express created a worldwide network for credit cards. It was only in 1958 that the concept of revolving credit was incorporated into the cards. BankAmericard, issued by Bank of America, in 1958 has the distinction of being one of first modern credit cards.
Credit cards were widely accepted and adapted by the masses by mid twentieth century. The usage of the credit cards had also spread beyond the United States to Canada and the UK. Though credit cards are now widely used across the globe, their acceptance rate is still low in some cash oriented societies. In Japan, only large businesses accept credit cards. Recent trend is about issuing co-branded or affinity cards where credit card issuing companies collaborate with other businesses.
Credit cards are issued by financial institutions. Once an account is approved, the holder can use the cards to make various types of payments. The cards can only be used with the merchants willing to accept them. Generally, merchants convey their preferred cards through acceptance marks. The modus operandi of a credit card includes signing of a slip by credit card holder to indicate the agreement to pay the credit issuing company. However, many merchants also accept verbal authorization. The internet usage of credit cards is also increasing.
Credit cards work on electronic verification system. This system allows merchants to quickly verify the validity and authenticity of the card. The merchant can also check the user’s creditworthiness. Credit cards now also process Card Not Present Transactions. This process is used when a card is not physically presented. This occurs in cases of internet transactions and telephonic transactions. In such cases, merchant may ask for additional information such as card’s expiry date or the security code.
Credit card issuing company sends a statement to the holder each month. This statement shows the purchases done through the card and any other allied charges. It also shows the total amount owed by the credit card holder. The credit card issuing companies also allow the holder to dispute any charges. The credit card holder may choose to pay the entire due amount or the minimum amount due as shown in the statement. If the balance is not paid in full, then credit card company charges interest on the amount owed. Such interest is generally higher than the interest levied for other types of loans.
Credit card provides interest free loan to the credit card holder, provided the holder pays the balance in full on the due date. However, if the balance is not paid in full, then the card issuer may levy interest on the new purchases right from the date of transaction. A credit card may act as a simple instrument of revolving credit or it may be used as a sophisticated financial tool.
Credit cards may offer several other features as well. These features may include facility to transfer balance. The credit card issuing company may charge different interest rates on different features. It may offer to charge lower interest rate on balances transferred from other accounts. In such cases, the company has the discretion to allocate the payments. The payments are generally directed towards the balances with lowest rate of interest. Such allocation is continued until the balance is fully paid. After that, the payments are directed towards the balance with second lowest rate and so on.
Credit card offers various benefits to its holder. The foremost benefit is the convenience. Credit card lets user obtain small short term loans on a quick notice. Credit card also offers various protections to the users. These protective measures differ from company to company. Many credit cards offer additional benefits like enhanced warranties, loss coverage and rental car insurance etc. Some credit cards also offer reward points for the qualified purchases. Such reward points can then be exchanged for goods, services or cash.
Despite all the benefits, credit cards may also prove to be detrimental to some clients. Generally, such problems arise due to financial indiscipline on the part of credit card user. Some credit cards charge lower interest rate in the beginning and later the interest rates are escalated. Some credit card companies also levy universal default rate. Such rates are applied when a client defaults on an unrelated account of the same provider. Such rate may have snowball effect and may cause serious financial damage to the user.
Credit card companies may levy various other charges and fees such as discount fees and interchange fees. Such charges are levied on all transactions carried out using the credit card. There are several studies showing that credit cards lead to weaker self regulation among the users. Credit card companies offer grace period to its holders. Grace period is the time during which the client needs to pay off the balance to avoid interest payment. Different credit card companies have different policies regarding grace period.
Credit cards also offer benefits to merchants. Credit cards are more secure method of receiving payment than cheques. In a couple of ways, credit card transactions are even more secure than cash transactions since the chances of theft and back office expenses are reduced. With the help of credit cards, a business is relieved from the responsibility of evaluating a user’s creditworthiness. This responsibility is transferred to the credit card issuing company in case of credit card transaction.
Merchants also have to incur some fees in order to accept credit cards. Generally, there is some time lag in receiving payment from the credit card company for the transactions made. Banks also charge commission or discount fee for services offered by the credit card. This fee may be partially fixed and party variable, dependant on the transaction amount. Generally, such fee amount to 1 to 3 percent of the transaction amount. Banks also require merchants to lease processing terminals. Banks may also stipulate certain other conditions.
There are several parties involved in the process of using a credit card. A cardholder is the person to whom the card is issued. There is a card issuing bank and a merchant, from whom goods or services are obtained. Acquiring bank is the financial concern which accepts credit card payment on the behalf of the merchant. Other parties are Independent Sales Organizations, merchant account, credit card associations and transaction networks. In some cases, affinity partners and insurance providers are also involved.
Various steps involved in a credit card transaction are authorization, batching and Clearing & Settlement. The further steps in the transaction cycle are funding and chargeback. A chargeback only occurs when there is some dispute regarding the transaction. In such case, the payment to the merchant is withheld. There are several types of credit cards issued by the banks. A secured credit card is the one where it is backed by a deposit account. Some credit cards come in the form of prepaid cards, though in the strictest sense of the words, such cards may not be considered to be credit cards.
There are several security issues related to credit cards. The foremost concern is about the physical security of the card. Credit card holders and issuing companies are now also dealing with internet frauds. Credit card issuing banks are now coming up with new measures to control the damage.
Credit Cards are not only helpful to the holder and merchants, but also provide valuable services to the economy as whole. Credit card transactions have impact on the holder’s credit history. Credit cards divisions have also generated large revenue and profit for the issuing banks. Various parties to the credit card incur different costs. Issuing banks have to incur charges related to promotion, charge offs, rewards and operating expenses. Banks earn revenue from interchange fee, interest on outstanding balances and various other fees charged to the clients. Such fees may be related to late payment, overdue payment, foreign currency transaction and membership fee. The banks may also charge over limit charges.