credit cards

CREDIT-CARD

A credit card is a system of payment named after the small plastic card issued to users of the system. A credit card is different from a debit card in that it does not remove money from the user's account after every transaction. In the case of credit cards, the issuer lends money to the consumer (or the user). It is also different from a charge card (though this name is sometimes used by the public to describe credit cards), which requires the balance to be paid in full each month. In contrast, a credit card allows the consumer to 'revolve' their balance, at the cost of having interest charged. Most credit cards are the same shape and size, as specified by the ISO 7810 standard. Contents

1 How Credit Cards work
1.1 Grace period
1.2 The merchant's side
1.3 This process involves the following parties:
1.4 Authorization
1.5 Batching
1.6 Clearing and settlement
1.7 Funding
1.8 Secured credit cards
1.9 Prepaid credit cards
1.9.1 Neutral consumer resources
1.9.1.1 Canada
2 Features
3 Security
4 Profits and losses
4.1 Costs
4.1.1 Interest expenses
4.1.2 Operating costs
4.1.3 Charge offs
4.1.4 Rewards
4.1.5 Fraud
4.2 Revenues
4.2.1 Interchange fees
4.2.2 Contract terms
4.2.3 Industry's jargon for customer categories
4.2.4 Interest on outstanding balances
4.2.5 Fees charged to customers
5 Neutral consumer resources
5.1 Canada
6 History
7 Controversy
7.1 Minimum payments
7.2 Trailing interest
7.3 Hidden costs
8 Credit card numbering
9 Credit cards in ATMs
10 Credit cards as funding for entrepreneurs
11 Collectible credit cards
12 References
13 See also
14 External links

How Credit Cards work
An example of the front of a typical credit card:
Issuing bank logo
EMV chip
Hologram
Card number
Card brand logo
Expiry Date
Cardholder's name


An example of the reverse side of a typical credit card:
Magnetic Stripe
Signature Strip
Card Security Code
A user is issued credit after an account has been approved by the credit provider (often a general bank, but sometimes a captive bank created to issue a particular brand of credit card, such as Wells Fargo or Bank of America), with which the user will be able to make purchases from merchants accepting that credit card up to a pre-established credit limit. When a purchase is made, the credit card user agrees to pay the card issuer. The cardholder indicates their 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 Card not present (CNP) transaction.
Electronic verification systems allow merchants to verify that the card is valid and the credit card customer has sufficient credit to cover the purchase in a few seconds, allowing the verification to happen at time of purchase. The verification is performed using a credit card payment terminal or Point of Sale (POS) system with a communications link to the merchant's acquiring bank. Data from the card is obtained from a magnetic stripe or chip on the card; the latter system is in the United Kingdom commonly known as Chip and PIN, but is more technically an EMV card.
Other variations of verification systems are used by eCommerce merchants to determine if the user's account is valid and able to accept the charge. These will typically involve the cardholder providing additional information, such as the security code printed on the back of the card, or the address of the cardholder. Each month, the credit card user is sent a statement indicating the purchases undertaken with the card, any outstanding fees, and the total amount owed. After receiving the statement, the cardholder may dispute any charges that he or she thinks are incorrect (see Fair Credit Billing Act for details of the US regulations). Otherwise, the cardholder must pay a defined minimum proportion of the bill by a due date, or may choose to pay a higher amount up to the entire amount owed. The credit provider charges interest on the amount owed (typically at a much higher rate than most other forms of debt). Some financial institutions can arrange for automatic payments to be deducted from the user's accounts. Credit card issuers usually waive interest charges if the balance is paid in full each month, but typically will charge full interest on the entire outstanding balance from the date of each purchase if the total balance is not paid.
For example, if a user had a $1,000 outstanding balance and pays it in full, there would be no interest charged. If, however, even $1.00 of the total balance remained unpaid, interest would be charged on the full $1,000 from the date of purchase until the payment is received. The precise manner in which interest is charged is usually detailed in a cardholder agreement which may be summarized on the back of the monthly statement. The general calculation formula most financial institutions use to determine the amount of interest to be charged is APR/100 x ADB/365 x number of days revolved. Take the Annual percentage rate (APR) and divide by 100 then multiply to the amount of the average daily balance divided by 365 and then take this total and multiply by the total number of days the amount revolved before payment was made on the account. Financial institutions refer to interest charged back to the original time of the transaction and up to the time a payment was made, if not in full, as RRFC or residual retail finance charge. Thus after an amount has revolved and a payment has been made that the user of the card will still receive interest charges on their statement after paying the next statement in full (in fact the statement may only have a charge for interest that collected up until the date the full balance was paid...i.e. when the balance stopped revolving).

The credit card may simply serve as a form of revolving credit, or it may become a complicated financial instrument with multiple balance segments each at a different interest rate, possibly with a single umbrella credit limit, or with separate credit limits applicable to the various balance segments. Usually this compartmentalization is the result of special incentive offers from the issuing bank, either to encourage balance transfers from cards of other issuers, or to encourage more spending on the part of the customer. In the event that several interest rates apply to various balance segments, payment allocation is generally at the discretion of the issuing bank, and payments will therefore usually be allocated towards the lowest rate balances until paid in full before any money is paid towards higher rate balances. Interest rates can vary considerably from card to card, and the interest rate on a particular card may jump dramatically if the card user is late with a payment on that card or any other credit instrument, or even if the issueing bank decides to raise its revenue. As the rates and terms vary, services have been set up allowing users to calculate savings available by switching cards, which can be considerable if there is a large outstanding balance (see external links for some on-line services). Because of intense competition in the credit card industry, credit providers often offer incentives such as frequent flier points, gift certificates, or cash back (typically up to 1 percent based on total purchases) to try to attract customers to their program. Low interest credit cards or even 0% interest credit cards are available. The only downside to consumers is that the period of low interest credit cards is limited to a fixed term, usually between 6 and 12 months after which a higher rate is charged. 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.

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 55 days depending on the type of credit card and the issuing bank. A Lapse is the termination of a policy because premiums are not paid before the end of the Grace Period. Some policies allow for Reinstatement after certain conditions are met. Usually, if a customer is late paying his balance, finance charges will be calculated and the grace period doesn't apply any more.

The merchant's side
An example of street markets accepting credit cards
For merchants, a credit card transaction is often more secure than other forms of payment, such as cheques, because the issuing bank commits to pay the merchant the moment the transaction is verified, whether the consumer pays their bill or not. The only exception would be the American Express card, which does not guarantee payment to the merchant if the consumer defaults on payment. For each purchase, the bank charges a commission (discount fee), to the merchant for this service and there may be a certain delay before the agreed payment is received by the merchant. In addition, a merchant may be penalized or have their ability to receive payment using that credit card restricted if there are too many cancellations or reversals of charges.

In some countries, like the Nordic countries, banks guarantee payment on stolen cards only if an ID card is checked and the ID card number/civic registration number is written down on the receipt together with the signature. In these countries merchants therefore usually ask for ID. Non-Nordic citizens, who are unlikely to possess a Nordic ID card or driving license, will instead have to show their passport, and the passport number will be written down on the receipt, sometimes together with other information. Some shops use the card's PIN code for identification, and in that case showing an ID card is not necessary.

This process involves the following parties:
Cardholder: the owner of the card used to make a purchase
Merchant: the business accepting credit card payments for products or services sold to the cardholder
Acquirer: the financial institution or other organization that provides card processing
services to the merchant
Card association: a network such as VISA� or MasterCard� (and others) that acts as a gateway between the acquirer and issuer for authorizing and funding transactions
Issuer: the financial institution or other organization that issued the credit card to the cardholder

Affinity partner: some institutions lend their name to an issuer to attract customers that have a strong relationship with that institution, and get paid a fee or a percentage of the balance for each card issued using their name. A typical affinity partner will be a sports team or a university
The flow of information and money between these parties�always through the card associations�is known as the interchange, and it consists of a few steps:

Authorization
When the cardholder pays for the purchase the merchant performs some risk assessment and may submit the transaction to the acquirer for authorization. The acquirer verifies with the issuer�almost instantly�that the card number and transaction amount are both valid, and informs the merchant on how to proceed. The issuer may provisionally debit the funds from the cardholder's credit account at this stage.

Batching
After the transaction is authorized it is then stored in a batch, which the merchant sends to the acquirer later to receive payment (usually at the end of the day)

Clearing and settlement
The acquirer sends the transactions in the batch through the card association, which debits the issuers for payment and credits the acquirer. In effect, the issuers pay the acquirer for the transactions.

Funding
Once the acquirer has been paid, the merchant receives payment. The amount the merchant receives is equal to the transaction amount minus the discount rate, which is the fee the merchant pays the acquirer for processing the transaction. The entire process, from authorization to funding, usually takes about 3 days. However, many merchant card processors offer next-day deposits to customers subject to type of banking account.

In the event of a chargeback (when there's an error in processing the transaction or the cardholder disputes the transaction), the issuer returns the transaction to the acquirer for resolution. The acquirer then forwards the chargeback to the merchant, who must either accept the chargeback or contest it.

Secured credit cards
A secured credit card is a type of credit card secured by a deposit account owned by the cardholder. Typically, the cardholder must deposit between 100% and 200% of the total amount of credit desired. Thus if the cardholder puts down $1000, he or she will be given credit in the range of $500�$1000. In some cases, credit card issuers will offer incentives even on their secured card portfolios. In these cases, the deposit required may be significantly less than the required credit limit, and can be as low as 10% of the desired credit limit. This deposit is held in a special savings account. Credit card issuers offer this as they have noticed that delinquencies were notably reduced when the customer perceives he has something to lose if he doesn't repay his balance. The cardholder of a secured credit card is still expected to make regular payments, as he or she would with a regular credit card, but should he or she default on a payment, the card issuer has the option of recovering the cost of the purchases paid to the merchants out of the deposit. The advantage of the secured card for an individual with negative or no credit history is that most companies report regularly to the major credit bureaus. This allows for rebuilding of positive credit history. Although the deposit is in the hands of the credit card issuer as security in the event of default by the consumer, the deposit will not be credited simply for missing one or two payments. Usually the deposit is only used as an offset when the account is closed, either at the request of the customer or due to severe delinquency (150 to 180 days). This means that an account which is less than 150 days delinquent will continue to accrue interest and fees.