Have you ever wondered how do credit cards work? We all know what credit cards are; they are an unsecured borrowing facility offered by NBFCs and banks with a defined credit limit. We can spend up to our spending limits and then pay the money back when it is due or convert it into EMIs and pay as per our convenience. Credit cards have a revolving account, unlike car or personal loans where we have to pay set instalments. Hence, cards let us borrow funds on the same account repeatedly as long as we pay our dues timely.
How do credit cards work?
You can borrow money up to your credit limit using your credit card and settle it when the due date arrives. When you spend money, that amount is deducted from your limit, and as you pay it, the same amount is added back to your limit. Hence, you have continuous access to funds as long as you avoid maxing out your credit card.
For example, you have a Bajaj Finserv RBL Bank Credit Card with a limit of Rs. 1,00,000. You buy a phone for Rs. 30,000 and convert the bill into EMIs to be paid over 6 months. You also buy headphones worth Rs. 5000. Now, your credit limit will be 65,000 rupees. When Bajaj Finserv sends you the bill, it will have charges and fees and Rs. 10,000 as the due amount. This includes 5,000 for the headphones and 5,000 for the phone EMI. Once you make the payment, your credit limit will increase to 75,000 rupees. This cycle will continue as long as you pay your bills.
However, if you do not make complete payments, you will be charged with financial charges or interest on the outstanding amount. The amount will increase until you make a complete payment and settle all outstanding debt.
Online credit card payments:
Imagine you are using travel credit cards to make payments. When you use this card to buy something online, then the merchant will ask you for the following details:
- The CVV and the expiry date of your credit card.
- Your credit card number
- Billing details
- Your name
After filling in the details, when you choose "pay', this information is sent back to the card issuer through a payment gateway. The card issuer will then send an OTP on the registered contact number, or sometimes the OTP is sent to the email ID. After submitting the right OTP, the transaction will be approved or completed.
Offline credit card payments
Have you ever wondered what happens when your credit card is swiped for a payment? First, let us look at the parties involved in this process.
- Acquirer Bank - This is the merchant's bank.
- Merchant- The shopkeeper or the merchant is the person to whom you are making the payment.
- Issuer Bank - This bank has provided you with a credit card.
- Network - The network helps facilitate the transaction. The most popular networks are MasterCard and Visa.
Now, here is what happens when you swipe your card. This process has four main parts, which are as follows:
- Authorization- The merchant swipes or inserts your card in the machine. Then, you enter your PIN. The network then checks your account balance, ensuring it is enough, and if it is, then the transaction is approved.
- Batching - The merchant sends the receipt to his bank to receive payment.
- Clearing- The acquiring bank uses the network to send the request to the issuer bank. After deducting fees, the issuer bank pays the amount to the acquirer bank.
- Funding - The acquirer bank deducts merchant fees from the payment and pays it to the shopkeeper.
No matter what mode you choose, it is always best to have an understanding of how credit cards work for online and offline payments.