Credit card has become inevitable in modern day life. Credit card is helpful in many emergency need. Now a days it is used even for convenience and also to avail various offers. Let us understand how credit card work in details.

What is credit card ?

It is a physical card embedded with a chip for carrying out financial transactions. The issuer is either a bank or financial institute, which sanction a financial limit against the card on the basis of the card holder’s profile and repaying capacity. It is unsecured meaning you don’t have to give any security for it. The sanctioned amount can be used, repaid and be used again. Therefore it is a revolving in nature. Some of the associated terms with credit card are

• Card limit – Each card will have a maximum limit upto which it can be used. This limit is fixed at the time of issuing the card. It can change upward or downward during the life of the card, depending upon its utilisation and creditworthiness of the card holder.
• Interest free period – All credit card provide an interest free period ranging from 20 to 50 days. During this period. The card holder can utilise the limit and repay without any additional cost.
• Interest – When the card holder fails to repay the utilised amount during the interest free period, it attracts interest. The Annual percentage Rate (APR) varies from 24% to 50% depending upon issuer/bank. Since the limit is revolving in nature, the interest is applied on daily basis. Therefore, the annual rate works out very high.
• Billing cycle – Generally, all the transactions both debit and credit are processed for levying interest, charges etc in a monthly period with a start date and end date. This is known as billing cycle. Transactions after the end date is processed in the next cycle.
• Statement – Based on billing cycle a statement is prepared and provided to the card holder. The statement will list out all the transaction during that period, applicable charges and interest. It will also indicate sanctioned limit, outstanding amount to be paid.
• Minimum payment – The statement will also indicate an amount which the card holders have to pay, if not in a position to pay the entire outstanding amount. It is approximately 10% of outstanding dues plus other charges. Non-payment of outstanding or minimum dues will lead to blocking of the card for further use.
• Credit utilisation ratio – The utilised amount divided by sanctioned or credit limit gives the credit utilisation ratio. It indicates how dependent is the card hold on the credit card for his transactions. A credit utilisation ratio of around 30% is considered good. A higher credit utilisation ratio will lead to low credit score, which is not good.

How credit card work ?

There are four parties involved in a credit card transaction.

1. When we present a credit card to a merchant, it puts the card in a Point of Sale (POS) machine. It asks for authentication through Personal Identification Number (PIN). Once the authentication is established the ‘Network’ provider check for availability of balance. The network namely Mastercard, Visa, Amex, Rupay etc are a computerised system which are connected to banks and facilitate credit card transactions.
2. If the balance is available, the network provider allows the transaction.The network sends all such transactions of the day in batches to the banker of the merchant known as acquiring bank for collection of payment.
3. Acquirer bank send request through the network for payment to the respective issuer bank of credit card.
4. The issuer bank after deducting the applicable charges pay the amount to the acquiring bank.
5. The acquiring bank after deducting the merchant fee transfer the balance to the merchant account.

Advantage of credit card

1. It ensures availability of credit for any needs. Thereby it helps to maintain liquidity as your cash remain unutilised.
2. There are provisions for easy repayment. One can buy now and pay later as per convenience.
3. There are many incentives and offer on use of credit card. It brings additional benefits to card holder.
4. Transactions are recorded in a statement, which cardholder can refer at time of need. The cardholder can understand his spending pattern and decide to implement a financial planning.
5. The cardholders get certain privileges as members reward points, access to lounge in airport and in certain arenas, clubs.

Disadvantage of credit card

1. Since credit is easily available there is a tendency to overspend.
2. There are hidden cost and charges. If same is considered effective price is high
3. The minimum payment is a trap. People tend to postpone the outstanding dues by paying minimum dues. It accumulates to larger amount later.
4. Since the applicable interest is applied and compounded on daily basis, the effective interest works out to very high.
5. There is high risk of fraud as credit card details are shared in online platforms. Also in case of loss, fraudster may access its credit limit.

The 7 right way to use credit card are

1. Use only when it is absolutely necessary
2. Use to avail underlying benefits like, rewards point, discount, offer etc.
3. Always pay within the billing cycle to avoid interest application.
4. Don’t exceed the credit utilisation ratio above 40%
5. Read the terms and condition before using the card
6. Don’t do impulsive buying
7. If any large payment is done with credit card, opt for EMI option to lessen interest burden.

The article will definitely help in knowing credit card functioning and deciding the right approach. Read the post financial planning to know how to become more financially discipline.