What Is Credit Card & How Do Credit Cards Work
A Credit Card is a wonderful convenience that lets you pay for your purchases online or offline without cash. But how does a Credit Card work?
Let’s begin by examining a Credit Card carefully. A Credit Card comes with the following:
- A number that uniquely identifies it
- An expiry date
- The name of the holder
- The logo of Visa or Mastercard – the two companies that provide the infrastructure and systems that process Credit Card transactions.
On the back of the Credit Card is:
- A magnetic strip or chip
- The CVV number. This is needed for online transactions.
How do Credit Cards work? Let’s take a look at what happens when you use your Credit Card at a retail store.
Step 1: Here’s the first step of how Credit Cards work. You have completed your purchases at your favourite store and use your Credit Card at the checkout counter. The storekeeper will swipe your card or insert it into a POS or point of sale machine. In most cases, the store will ask you to enter a PIN (personal identification number) to authenticate the transaction.
Step 2: The machine reads the strip or chip (which contains information to identify the card) and sends the information along with the PIN to your issuing bank (for example, HDFC Bank if you have an HDFC Bank Credit Card). If everything looks all right (credit limit, identity, validity, etc.), the bank approves the purchase.
Step 3: If the transaction is approved, the machine prints a pair of charge slips or receipts – the retailer retains one and gives you the other copy. In rare cases, where a PIN is not required, the retailer will request you to sign a copy of the charge slip.
You are billed for the transaction in the next statement, and the retailer receives the money after a few days. The whole process works seamlessly on systems and technology provided by Visa or Mastercard.
This should answer the question of how do Credit Card payments work. Now let’s look at how a Credit Card can be used over the Internet.
How do Credit Cards work online?
When you are paying for purchases online, the e-commerce store will ask you for the following details:
- Choose whether it is Visa or Mastercard
- 16-digit card number,
- Expiry date,
- Name as printed on the card
- Billing address (sometimes)
Once you hit pay, the information is sent to your bank via a payment gateway. The bank sends an OTP or one-time password to your registered email ID or mobile number to authenticate the transaction. If the OTP is correct, then your transaction is complete.
So we now know the answers to two questions: how do Credit Cards work, and how Credit Card payments work. Now let’s look at some of the terminologies that will help you understand how do credit cards work.
Interest: This is an essential aspect of how Credit Cards work. By using a Credit Card, you are taking money on credit from the issuer. It’s a bit like a loan, on which you may have to pay interest. However, this is applicable only if you don’t pay the entire bill that you get. If you leave some amount pending, you will be charged interest on it. Another thing you need to understand about how do Credit Cards work is that the interest charged is every month, and not on an annual one. For example, the interest charged could be 3 percent a month, or around 36 percent a year.
Credit limit: Every Credit Card has an upper limit beyond which you cannot spend. If you try to use the card after you’ve reached the upper limit, the transaction may be rejected by the Credit Card issuer. Various factors determine the credit limit – the type of Credit Card that you have, your income and ability to pay, any other debts that you may have, your credit score and your record of prompt payments. If your record is good, the Credit Card issuer will give you the option of increasing the Credit Card limit.
Billing cycle: This is the fixed period in which you can make purchases until you get the bill. If you make purchases at the beginning of the cycle, you will have a longer time of credit – that is you get more time before you pay for the transactions.
Minimum payment: There is a minimum amount that you have to pay on your Credit Card bill. If you don’t do that, you could pay a charge for it. You can carry forward any amount that is more than the minimum amount, but you will have to pay interest on it.
Balance: Balance is the sum you’ve spent using your Credit Card, but haven’t paid back yet.
To read more about Credit Card Safety, check here.
* Terms & conditions apply. Credit Card approvals are at the sole discretion of HDFC Bank Ltd. The information provided in this article is generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances.