How Credit Cards Work
Physically a credit card is a small plastic card that you can make payments with up to a certain limit allowed by the card issuer. More important is that a credit card is a debt and so whenever you spend with your credit card you are borrowing money. In this article we will look at how credit card works and what happens when you make a credit card payment.
Credit card is one of the most popular financial products in the market. It is also a successful one as it is a convenient alternative to make secure payments. It is also complex and hard to understand and we will try and break it down for you.
How do Credit Cards Work?
Credit cards are a flexible way of borrowing money. You are given a credit limit by the card issuer which means that every time you make payments with the credit card you are making payments in credit. You should not exceed your credit limit and once you have paid off what you have spent you can borrow and spend again. The good thing about credit cards is that you can avoid paying interest if you clear your balance in full before the due date. If you are unable to clear your balance in full, you will need to make a minimum payment and the outstanding amount is rolled over to the next month.
Remember credit cards are best for short term debts because credit card interest rates are higher than interest rates personal loan. With that said there are some 0% interest rates and balance transfer credit cards that can be cheaper than loans as long as you keep paying off your balance on time.
You get purchase protection from Consumer Credit Act when you use your Credit cards. This protection means that if you use your credit card to make a payment and the supplier has failed to meet his obligation to you, and you have pursued the supplier for remedies, you have a right to take action against your credit card provider.
To make a purchase online with your credit card, you will need to enter your card details, i.e. – name, billing address, card number, expiration date and last 3 digit security code at the back of your card. On a shop floor or on a point of sale machine, you will need to insert the credit card into a card reader so it can read the security chip on the card or simply just tap. When you make you payment online or in person with your credit card, the merchants credit card terminal asks your credit card issuer whether the card is valid and you have enough available credit. Your credit card issuer then sends back a message stating whether the transaction is approved or declined.
Types of Credit Cards
There are different types of cards that are designed for specific purposes, they include:
- Balance transfer cards
- Cash back credit cards
- Money transfer credit cards like avant money credit cards and an post credit cards that offer money transfer features.
- Travel credit cards like AER credit cards
- Rewards credit cards
What is a Credit Card Limit?
Credit limit is set by the card issuer when you make an application. The issuer uses your personal circumstances and credit history to decide if you are suited for a credit limit and what your limit is. A credit limit is the maximum amount you can spend on your card in total. As you continue using with your credit card and manage your credit card responsibly you will be able to increase your credit limit and sometimes the issuer may reduce your credit limit.
Fees and Terms of Credit Cards You Should Know
Each credit card company has a different fee structure. So if you take out a credit card, make sure you are fully aware of all the fees you could face.
- Annual fees: Many cards don’t charge annual fees in Ireland but some do.
- Cash withdrawal fee: This is charged when you withdraw money at ATMs with your credit card. This is usually be a fixed minimum charge or a percentage of the amount you withdraw. You start being charged interest as soon as you withdraw any cash
- Credit Score: Your credit score and credit history, as determined by central credit register, shows lenders your creditworthiness and deciding if they will approve credit to you.
- Late payment fee: You will get a penalty fee if you miss making your monthly minimum payment on the deadline on your credit card statement.
- Minimum monthly payment:
- Balance transfer fees: When you move existing credit card debt on to a balance transfer card, you might need to pay a fee. This is usually a percentage of the total balance.
- Money transfer fees: When you transfer money from your credit card to your current account the provider will charge a fee.
- Cross border handling fees: Most standard cards will charge fees to use a credit card abroad, unless you have a specialist travel credit card.
- Unpaid direct debits:
- Overlimit fees: Fees for going over your credit limit: The provider may also lower your credit limit or ask you to repay your card in full.
- Government stamp duty: This is an annual fee charged by the Government for each credit card account you have.
- Annual percentage rate – APR: This is the annual rate of interest charged on a credit card which includes all costs associated with the credit card over a year, such as the interest rate, Government stamp duty and any other fees applicable to the credit card.
- Variable rate: The rates of interest which we will charge you (other than the Balance Transfer Rate) are variable. This means the bank may change it from time to time.
- Interest rate: Except where an interest free period referred to below applies, interest is charged from the date of the transaction if you do not pay your balance in full by the due date
- Purchase rate: This is the annual rate of interest applied every time you use your card for a retail purchase
- Introductory rate on purchases: This is a special fixed interest rate of 0% on purchases for first 6 months of account opening, i.e. the 6 month period starts from account opening date, not the date the card is first used to purchase. Introductory rate on purchases is only available for new credit card customers and is not available on Affinity cards
- Interest free period: The number of days (up to 56) for which you will not be charged interest on purchases, as long as you pay your bill in full by the due date.
How Credit Card Interest Works?
Typically the credit card issuer gives you a grace period, which is a certain amount of time to pay back the entire amount that you’ve borrowed before you’ll be charged interest. The time period is usually 56 days. If you don’t pay off your full balance before the end of the grace period, the interest calculated is added to your balance.
How Credit Card Minimum Payment Works?
Minimum monthly payment is calculated by the terms of your credit card contract. You must make a monthly payment, either you pay off the balance in full before your due date or a minimum payment. If you miss this you will be fined a late payment fee.
How Credit Card Transactions Work?
What Happens When You Use Your Credit Card?
Credit card payments and transactions seems like a simple swipe of a card or entering your pin and then the payment is approved or declined. A lot happens behind the scenes to process your card payments and complete your transaction. It is useful to know the how a typical credit card transaction works.
First thing to be aware of is who are the parties to a credit card payment transaction. They are 5 main parties.
Credit Card holder: the customer who was issued the credit card and or is using the card to make a purchase.
Merchant: usually a business who sells goods or services to the cardholder.
Acquirer: is the merchant’s bank that receives a payment authorisation requests from the merchant and sends it to the issuing bank via the card network for authorisation.
Card Network: receives the credit card payment details from the acquirer, then sends payment authorization request to the issuing bank. Click here to learn of the four major payment networks – Visa, Mastercard, American Express and Discover
Issuer: is usually the cardholders bank and/or the financial institution that issued the credit card involved in the transaction. The issuer receives the payment authorization request from the credit card network and either approves or declines the transaction
The main steps in how credit card transactions work are:
- The customer purchases and pays for goods and services from the merchant with their credit card
- The merchant uses its point-of-sale system to capture customer card details and sends to the acquirer to authenticate payment
- The acquirer submits the transaction information to the card network to get authorisation from the issuer.
- Card network submits the transaction to the issuer and requests authorisation.
- The issuer approves or declines the transaction and routes the response back to the merchant.
- The issuer routed the payment to the acquirer who deposits the fund on the merchants account.
Credit Card Fees
When you use a credit card, you are borrowing money from the issuer to make a purchase payment and you pay it back in part or in full on a monthly basis. Credit cards is very similar to buy now pay later. When you use your credit card transaction for purchases, you may incur an interest charge on the outstanding balance if you don’t pay in full.
Besides purchases, Credit cards can be used for balance transfers and cash advances. When you use this services, you incur fees.
Click here for more on credit card charges.
How Credit Card Bill Payment Works
On a monthly basis, you will receive a credit card bill which states your statement balance, current balance and minimum payment.
The statement balance is the amount you owe at the end of the billing period while your current balance is the real time balance which includes the amount you owe plus charges, fees, interest and any unpaid balances.
Your bank or credit card issuer will provide you with different options
- Direct debit: Set up a direct debit on your current account with a set payment date
- Online payment: Log in your your credit card online account and manually make a payment
- Bank transfer: Log into your personal online bank account and make the payment transfer directly.
- Pay in-person at Branch: Make the payment at the bank branch safely and securely
- By Phone: Call the credit card issuer directly and make the payment with customer service or with an automated service line.
How to Avoid Credit Card Payment Charges
The good news is that if you pay your full balance each month before your payment due date you pay no interest on your credit card purchases. You save money from accruing interest charges.
Another way to avoid to lower your credit card balance and reduce your interest charges is making multiple payments before due date. Making early payment and multiple payments before your due date will lower your credit utilisation rate and help your credit score. You can avoid late fees by making at least the minimum payment due each month.
To keep on top of your credit card billing, it is essential to know your due date each month to avoid any penalties added to your existing balance. Here are a few ways you can do so
- Set up a direct debit
- Choose a convenient payment date
- Spend what you can pay back and monitor your spending
- Make multiple payments during he month.
- Sign up for alerts to let you know when you bill is due.
See our review of the best credit cards
