How Does A Credit Card Work?
Few people can survive without a credit card these days. However, despite the widespread use, many still don’t understand how one works. Here we explore the inner workings of a credit card – both financially and technically. But first, let’s start with the basics.
What is it?
It is often described as “plastic money”. That’s because one normally comes in the form of a plastic card. It usually measures 86 x 54 cm in size,and allows the cardholder to make purchases without cash.
In order to use one, the cardholder needs a pre-approved credit limit from the bank – this limit represents the maximum amount of money the bank agrees to lend to you for your purchases.
When we apply for a card from the bank, we are often able to choose between the different providers – AmericanExpress, MasterCard or Visa. But what are the roles of these companies? Why do the banks need them?
To answer your numerous questions about your card, here, we reveal everything you need to know about using a credit card.
What happens when you use your card to pay for purchases?
In every transaction, there are a few parties that are involved to make sure the entire payment process happens smoothly. The following will give you a good sense of what happens in a transaction.
Believe it or not, the process is actually quite complicated. To simplify matters, let’s assume you’re entering a shop and about to make a purchase with your card.
You, then, present your card to the cashier, who swipes it through a card reader or card terminal.
The card reader or card terminal reads the magnetic strip on the back of your card and sends key information (e.g. your card number, credit limit, expiration date, etc) to the shop owner’s bank (i.e. the merchant’s bank).
The merchant’s bank receives this information and checks that the transaction is valid.
The merchant’s bank then sends the purchase information to the relevant card company (i.e Visa, MasterCard or American Express).
Next, they will contact your bank to validate that your card is valid.
Upon confirmation from your bank, your card company then forwards the message to the merchant’s bank, which approves your transaction.
How the payment works?
At the end of each period, the merchant gives the bank all its transaction receipts (remember that receipt you sign when you buy something with your card?)
The bank then pays the merchant the total receipt amount.
At the same time, the bank sends a request to your card company asking for a settlement (or payment).
Your card company pays the merchant’s bank, and concurrently sends a payment request to your bank.
Your bank pays the card company, and proceeds to charge you for the amount you owe on your purchases.
And that’s essentially how a credit card works!