What is the Functioning of Credit Cards

In today’s digitally-driven world, credit cards have become an integral part of our financial transactions. With the convenience they offer, it is essential to understand their functioning to make informed decisions about their usage. In this article, we will delve into the intricacies of how credit cards work and their various functions.

To comprehend the functioning of credit cards, one needs to understand the key players involved – the cardholder, the merchant, the issuing bank, and the payment network. Let’s examine each of these components.

Firstly, the cardholder is an individual who applies for and holds a credit card. They can use this card for making purchases without immediate payment. Essentially, the cardholder borrows money from the issuing bank, provided they have credit available. This borrowed amount forms the cardholder’s outstanding balance, which needs to be repaid within a specified period called the billing cycle.

Moving on, the merchant is the business entity that accepts credit cards as a mode of payment. Once the cardholder makes a purchase using their credit card, the merchant requests authorization from the payment network to ensure that the cardholder has sufficient credit. If the transaction is approved, the merchant receives the payment from the cardholder’s issuing bank through the payment network.

Speaking of the issuing bank, it is the financial institution that provides credit cards to individuals. When a cardholder requests a credit card, the issuing bank evaluates their creditworthiness to determine the credit limit which represents the maximum amount the cardholder can borrow. Additionally, the issuing bank sets the interest rates and fees associated with the credit card.

Lastly, the payment network acts as the intermediary between the cardholder’s issuing bank and the merchant. It facilitates the authorization and settlement process, ensuring seamless transactions. Examples of payment networks include Visa, Mastercard, American Express, and Discover.

Now that we understand the key players let’s explore the functioning of credit cards in greater detail.

When a cardholder makes a purchase, their credit card information is entered or swiped at the point of sale. The merchant’s point of sale system sends this information to the payment network, which contacts the cardholder’s issuing bank for authorization. The issuing bank verifies the cardholder’s credit limit and other security details, subsequently responding to the payment network’s request.

Once the transaction is authorized, the merchant completes the purchase, and the payment network initiates the settlement process. The funds are transferred from the cardholder’s issuing bank to the merchant’s bank account, ensuring the payment is fulfilled.

It is important to note that credit cards offer a grace period known as the billing cycle. The billing cycle typically ranges from 25 to 30 days, during which the cardholder is not required to make any interest-bearing payments. However, if the outstanding balance is not paid by the end of the billing cycle, the cardholder is charged with interest on the remaining amount.

Credit cards also provide an extended line of credit, allowing cardholders to access cash through Automated Teller Machines (ATMs). However, this usually incurs high-interest rates and transaction fees.

Moreover, credit cards offer additional benefits such as rewards, cashback, and promotional offers, which vary based on the card issuer and type of credit card.

In conclusion, credit cards operate on a complex system involving cardholders, merchants, issuing banks, and payment networks. Understanding how they function is crucial to make responsible financial decisions and avoid unnecessary debt. By knowing the key players and the various processes involved, individuals can effectively utilize credit cards while enjoying their conveniences and perks.