Thinking Money | Free Financial Advice and Tips

How Do Credit Cards Work?

Posted on 23. Mar, 2009 in Credit cards

Credit cards are used worldwide as a method of payment for goods and services. The small, thin, plastic cards contain identifying information, including the card member’s name and their account number and signature. The credit card is used in lieu of cash, and the amount charged each month is paid off in installments on a monthly basis.

Decoding the Technical Works of a Credit Card

The number on the front of the card is the method of identification by which you are charged for the items or services you buy. This number identifies you electronically to the seller and your credit card company so that you can be billed for the charges incurred.

On the back of the card is a magnetic strip. This strip, also known as a track, is a read/write code that identifies your PIN, your country code, your currency, etc. When you or the cashier swipes the card, the point-of-sale terminal (POS) dials an automated number to authenticate the request for funds on the card. You are then required to key in your PIN on a touchpad. If it matches what the strip has encoded on it, then you go forward with the purchase.

Understanding the Financial Ramifications of Credit Cards

Insofar as the financial aspects work, a credit card essentially gives you a line of credit from the credit card issuer. The balance of what you owe on the card is paid off on a rotating monthly basis, and you are charged interest on the outstanding balance. If you want to keep your card payments low, you pay off your balance in full at the end of each billing cycle. If you keep your balance rotating, you pay the amount charged plus interest.

Each month, when you are billed, you have a scheduled due date by which you must pay a certain amount of the balance owed. If you do not pay the minimum amount owed, you are charged penalty fees that are added to your balance. Late payments on credit cards can lead to a host of problems, including suspension of the card, decreased credit lines, and lowering of your credit score.

Often, you can acquire a credit card with low or no interest. However, be aware that these interest rates do not last forever and typically expire within 6 months or a year. Credit card companies also offer many benefits to card members, such as free sky miles, gift certificates or cash back. However, these incentives do not diminish the amount of interest owed on outstanding balances.

Most credit cards have a grace period during which the consumer can pay back the amount owed on the card without interest payment. The grace period varies by credit card company, but most grace periods range from 20 to 58 days.

All in all, credit cards are an excellent tool for helping consumers to pay for necessities, but it is wise to keep an eye on the interest charges and strive to pay balances in full.

Tags: credit card interest, credit card management