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How does a credit card work?

    IndianMoney.com Research Team | Thursday, July 02,2009, 07:32 PM
 

A credit card is a card entitling its holder to buy goods and services based on the holder's promise to pay for these goods and services. The issuer of the card grants a line of credit to the consumer from which the user can borrow money for payment to a merchant or as a cash advance the user. Most credit cards are issued by local banks or credit unions and are the shape and size specified by the standard. Credit cards are issued after an account has been approved by the credit provider, after which cardholders can use it to make purchases at merchants accepting that card. When a purchase is made, the credit card user agrees to pay the card issuer. The cardholder indicates consent to pay by signing a receipt with a record of the card details and indicating the amount to be paid or by entering a (PIN). Also, many merchants now accept verbal authorizations via telephone and electronic authorization using the Internet, known as a Cardholder Not Present (CNP) transaction.

How credit cards work

Credit cards permit you to buy goods now and pay later called buying on credit. They aren't connected to your bank account. Like debit cards they can be used to buy goods in shops over the telephone and internet, with the same particulars being required. You can also get a cash advance by drawing money at bank cash machines. Your bank may offer you a credit card or you can apply for one to any institution offering one. The credit card provider will usually run checks to see if you've had problems repaying debts before offering you one called a credit check.

Each month, the credit card user is sent a statement indicating the purchases undertake with the card, any exceptional fees, and the total amount to be paid. After receiving the statement, the cardholder may dispute any charges that he or she thinks are incorrect. Otherwise, the cardholder must pay a distinct minimum proportion of the bill by a due date, or may choose to pay a higher amount up to the entire amount allocated. The credit provider charges interest on the amount billed if the balance is not paid in full. Some financial institutions can arrange for automatic payments to be deducted from the user's bank accounts, as a result avoiding late payment in total as long as the cardholder has sufficient funds.

Major Types of Credit Card

In Indian credit card market there are a number of credit cards being provided by banks and financial institutions. These cards give a wide selection of financial profit to holders.Following are a variety of credit cards available in India :

  • Co-branded credit card
  • Cash Back Credit Cards
  • Business Credit Cards
  • Student Credit Cards
  • Balance transfer credit card
  • Airline credit card
  • Silver credit card
  • Gold credit card
  • Platinum Credit Card

1. Co-branded credit card


Visa or MasterCard credit card together sponsored by a bank and retail merchant such as a department store. Co-branded cards can be issued at less cost than conventional retail private label cards and give issuing banks admission to new customers. Cardholders may be given incentives such as discounts on merchandise, rebates or discounts off purchases. A co-branded card has a tie-in with a specific merchant rather than an association or professional group.

2. Cash Back Credit Cards


Several credit cards will now offer you cash back incentives for using their credit cards. Depending on how much your balance is and how often you use the credit card, you can earn cash back for your purchase.

3. Business Credit Cards


A business credit card offers the business owner the opportunity to keep business and individual expenses separate. The credit card may suggest special business rewards and saving opportunity that go above and away from what the individual credit card owner may have. Since money management is necessary in effectively running a business, the card may offer an expense management service that will allow you to keep path of the outgoing money. You can attain additional credit cards for employees who may need them for travel expenses and such as well as have a higher credit border than you normally would on an individual credit card.

4. Student Credit Cards


Numerous credit card companies will issue student credit cards that have lower credit limits and fewer incentives to help remain their spending in check. Still, take note. Many college students graduate with a credit balance that averages between 3,000 and 7,000 and with interest rates; this can be a real problem when trying to pay them off.

5. Balance transfer credit card


A balance transfer credit card is one in which you can transfer some of your debts and pay the sum off at a 0% interest rate for a set period of usually between six and 14 months.

6. Airline credit card


Airline credit cards that earn reward miles for discounted or free flights are a must have if you are a frequent flyer. Earning these valuable benefits can save a small fortune or free upgrades for your travel needs.

7. Silver credit card


Silver credit cards have been around since the beginning of credit cards in the mid-1950s. Today silver cards have been surpassed in prestige by gold credit cards and platinum credit cards and so have more normally come to be known as standard or basic credit cards.

8. Gold credit card


A gold-colored credit card, generally issued to customers with above average incomes, that may include additional benefits, for example, an overdraft at an advantageous interest rate, and may have an annual fee.

9. Platinum Credit Card


Platinum credit cards are generally offered to those individuals with good credit ratings and very high income. Platinum credit cards have many benefits and features compared to a silver or gold credit card. Conventional school of thought would find platinum credit cards to be a status symbol. However, relaxed rules and upper limits have brought them within reach of the average person too.

Advantages of Credit Card

Following are the advantages of credit cards

  • They allow you to make purchases on credit without carrying around a lot of cash.
  • They allow accurate record-keeping by consolidating purchases into a single statement.
  • They allow convenient remote purchasing - ordering/shopping online or by phone. They allow you to pay for large purchases in small, monthly installments.
  • Under certain circumstances, they allow you to withhold payment for merchandise which proves defective.
  • They are cheaper for short-term borrowing - interest is only paid on the remaining debt, not the full loan amount.
  • Many cards offer additional benefits such as additional insurance cover on purchases, cash back, air miles and discounts on holidays.

Disadvantages of Credit Card

Following are the disadvantages of credit cards

  • You may become an impulsive buyer and tend to overspend because of the ease of using credit cards. Cards can persuade the purchasing of goods and services you cannot really afford.
  • Credit cards are a relatively expensive way of obtaining credit if you don't use them carefully, especially because of the high interest rates and other costs.
  • Lost or stolen cards may result in some unwanted expense and inconvenience.
  • The use of a large number of credit cards can get you even further into debt.
  • Using a credit card, especially remotely, introduces an element of risk as the card details may fall into the wrong hands resulting in fraudulent purchases on the card. Fraudulent or unauthorized charges may take months to dispute, investigate, and resolve.

Tips for selecting the right Credit Card

Decided to go in for a credit card? But do not know how to select? The explosion of cards in the market would simply confuse you while choosing a card. You can, of course, choose to move with whatever comes your way, or whatever your friend recommends, but you at least need some tips and tricks that could help you to get a better card. Following are the things to be considered while choosing a credit card.

  • Go through the joining fee and annual fee
  • Move on the Add-on card fee
  • Interest rate
  • Is it a Global card or what?
  • Lost card liability
  • Is immediate cash withdrawal possible
  • We can be in the free credit period
  • Do you have a Helpline

1. Go through the joining fee and annual fee


Normally, a card with a higher annual fee enjoys more benefits like higher credit limit, higher accident insurance cover, accessibility to airport lounges, travel discounts etc. Or at least this used to be the case. With cut-throat competition between the card issuing banks, players are ready to waive joining fees and also one-year membership fees for anyone. Grab these offers, or negotiate this for yourself.

2. Move on the Add-on card fee


If you are interested in buying add-on cards for your children, spouse or friend, ask for the add-on card fee. Remember that you will be settling the bills on the add-on card that you so movingly gift to someone dear to you - the statement will come to you, and the responsibility for payment is yours (as far as the credit card company is concerned)

3. Interest rate


Remember, while the upfront one off fees are bread and butter for the credit card company, this is the jam! If you're the kind who forgets to pay on time, or likes to live it up and live off credit, the interest rate would be of supreme importance. Most credit card companies will charge somewhere between 2% to 3 % per month. It is always worthwhile to pay off the entire amount on outstanding date, or, if you have a large bank balance, look for card companies that provide the transfer balance facility. The balance transfer rate is lower for a certain period and then the normal rates apply.

4. Whether is it a Global card or what?


Nowadays this could be useful to you if you are an overseas traveler. A Global card can be used for paying expenses in foreign currency as you use a credit card to pay in rupees. Nowadays, a Global card is being issued at the same cost as for a like domestic one. It is better to have a global card, especially if there is no premium attached.

5. Lost card liability


More Card issuers mention in the brochures that lost card liability is Rs 1000.you should careful in this that is actually after it is report to the Bank. The liability is in reality is unlimited before reporting (in cases like this, you would actually thank the credit limit because though the liability is unlimited - the ceiling should logically be your credit limit, and the outlets accepting your stolen card should actually check that you (or the person who stole your card) haven’t exceeded your credit limit). Avoid banks that make you liable for card misuse for a single minute after reporting it.

6. Is immediate cash withdrawal possible?


Check out if the Bank has any ATMs near your house or workplace? This surely helps in times of emergency.

7. Can you be in the free credit period


The days of credit one gets depends on the statement date and the date of transaction. On a usual, you could assume you would get around 20 days of free credit. Though, if you buy just after the statement date, you could end up getting up to 50 days of credit. Look for cards which you are using which give you the highest free credit period.

8. Do you have a Helpline


A 24-hour Helpline service from the Card Company helps the cardholders throughout the non-banking hours. Reporting of theft, checking of available credit limit and some other enquiries can be made by the cardholder. In the end, like everything else in life, the card you want is really matters to you - what matters the most to you - credit, reach, the freebees, international reach or a combination of parameters. Use our card category on the left bar to simply list out the names of the cards, or choose by bank name and see the cards they offer.

A comparison of Debit cards and Credit cards

Credit Card


Every time you use a credit card you are really borrowing money that is made available to you by a bank. The institution pays the debt to the vendor and in turn, you pay the money back to the bank. By signing up for a credit card you agree to pay back the money that you borrowed, in addition to any interest drawn on the amount you borrowed.

Debit Card


Debit cards take funds directly from the money that you have in your bank account. With a debit card you don't have to carry cash or checks and it is very suitable to shop at a variety of places including gas stations, grocery stores, restaurants and retail stores. They give instant admission to your money and are accepted worldwide. Debit cards are used much like credit cards.

How Interest is charged on Credit Cards?

Credit card issuers regularly surrender interest charges if the balance is paid in full each month, but naturally will charge full interest on the entire outstanding balance from the date of each purchase if the total balance is outstanding.

For example; if a user had a 10,000 operation and repaid it in full within this grace period, there is no interest charged. If however even 1000 of the total amount remains due, interest would be charged on the 1,000 from the date of purchase until the payment is received. The exact manner in which interest is charged is usually detailed in a cardholder agreement which may be summarized on the back of the monthly statement.

What is Grace period?

A credit card's grace period is the time the customer has to pay the balance before interest is charged to the balance. Grace periods vary, but usually range from 20 to 40 days depending on the type of card issued by the bank. Generally, if a customer is late paying the balance, finance charges will be calculated and the grace period does not apply. With the majority credit cards there is no grace period if there is any outstanding balance from the previous billing cycle or statement (interest is applied on both the previous balance and new transactions). However, there are some credit cards that will only apply finance charge on the previous or old balance, excluding new transactions.

Benefits to customers

Since of strong competition in the credit card industry, credit card providers often offer incentives such as frequent flyer points, gift certificates, or cash back (normally up to 1 percent based on total purchases) to try to attract customers to their programs. However it should be noted that the incentive is insignificant to the interest charged for carrying a balance. Low interest credit cards or even 0% interest credit cards are available. However, services are available which alert credit card holders when their low interest period is due to expire. Most such services charge a monthly or annual fee.

IndianMoney.com Research Team

The research team at IndianMoney.com comprises of certified and experienced professionals who share the company's vision to make every Indian financially literate by equipping every Indian with right and unbiased advice. IndianMoney.com research team provides newsletters, articles, videos and FAQs on various financial products and concepts only to help you make wise financial decisions.

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