• How do credit cards work

    Using a credit card is like getting a loan from the bank. When you charge something on your card, you are borrowing that money till you pay it back at the end of the month. The credit card companies charge interest in exchange for the loan. This interest is to be paid along with the purchases made.

    Credit cards are a financial tool that will save you money if you were to ruin your finances. You can either build a good credit score if you know how a credit card works if you don’t understand how it works, then you will end up in a bigger debt than before.

    What are the parties involved?

    The following parties are involved with your credit card:

    • Cardholder: You hold the card and use it at your convenience.
    • Merchant: This is the physical store that you go to make purchases. It can also be an e-commerce website.
    • Acquiring bank: This is the bank which provides the POS machine or e-commerce payment software.
    • Issuing bank: This bank issues the credit card to the cardholder. The issuing bank will have to pay the acquiring bank every time a purchase is made using the credit card.
    • Card network: The companies that process the credit card payments. They act as gateways between the merchant and the acquiring bank. The primary card networks are Visa, American Express and MasterCard.

    What happens when you swipe your credit card?

    When you are using your credit card to make a payment, the following takes place:

    • The merchant swipes the card at the POS machine and you will key in your PIN number.
    • The transaction data then gets submitted to the acquiring bank.
    • The acquiring bank will forward the payment request to the card network to validate it.
    • The card network will then send a request for approval to the issuing bank.
    • The issuing bank will then check for the card validity, credit limit, etc. and then approve or decline the transaction and send the response to the card network.
    • The card network then forwards this message to the acquiring bank.
    • When the transaction is approved, the merchant is notified that the acquiring bank has processed the payment.
    • Then two receipts will be generated. One receipt will be handed over to you and the merchant keeps the other one.
    • The merchant will sent the entire batch of sales transactions to the acquiring bank to receive the payment.
    • The acquiring bank will send the transaction data to the card network.
    • The card network routes the transaction to the issuing banks and issues a debit to settle the payment. Credit is issued to the acquiring bank which can then be reimbursed by the merchant.
    • The issuing bank will post debit in your credit card account.
    • The debit is shown in your credit card statement and you can pay your credit card bill when it is due.

    Credit card payments

    You can pay the amount due in full before the due date, this way you will not be charged any interest. The right way to use a credit card is to make the payment in full each month. When you aren’t charged any interest, you can accrue substantial rewards. It will also help you build a good credit score when you are paying your balance in full every month.

    If you are carrying over the balance for the next month, you will be charged interest on the balance. The interest for cash advances is higher than the interest charged on the purchases of goods and services.

    If you wish to enjoy no interest on your credit card, you will have to pay the balance in full. The banks and credit card companies will wait for two billing cycles to determine if the interest will be waived off. You must ensure that you are paying the balance in full before the due date, otherwise you will not get the interest waiver if there is interest of the previous month carried forward.

    What can you use your credit cards for?

    Credit card lets you pay for goods and services. You can also take cash advance from your credit card. Although it is similar to that of a debit card, when you are making a purchasing and withdrawing money on your credit card it is taking a loan from the credit card company or the bank. You must remember that the money that is used to take the cash advance or to pay for the goods and services does not belong to you and you will be charged an interest on the amount borrowed.

    You can use your credit card to make payments online and shop anywhere for a certain fee. There are credit cards that offer rewards, air miles, etc. for making a particular type of transaction. There are cards that offer discounts for shopping, dining, travel, etc.

    Credit cards are nothing like debit cards, you are owing the money to the bank or the credit card company and if not paid in full before the due date, you will be charged an interest. If you are unable to pay the balance in full, you may end up getting charged a lot of interest and will eventually land in a huge debt. Therefore use the credit card only when you are sure that you are able to repay the balance at the end of the month. This will also help you build a good credit score.

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