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How Credit Cards Work

Credit cards operate on the principle of ‘Buy Now, Pay Later’, which is the concept of revolving credit. Essentially, a credit card issued by any financial institution allows you to make payments at Point-of-Sale (PoS) terminals or shop online. 

 

Credit cards have a pre-approved limit given to you as an advance, which you can repay at the end of each billing cycle. This is how credit cards work as a tool. To know more about how credit card payments work, read on.

Terms to Understand the Working of a Credit Card

To understand how credit cards work, you need to first know about the key terms and phrases associated with credit cards. Here is a closer look at important terms that can help you understand credit cards better. 

  • Credit Limit

The credit limit is the maximum amount you can spend on a credit card. For instance, if the credit limit on your card is ₹1 lakh, you can use your card to make payments or purchases up to ₹1 lakh. 

  • Billing Cycle

The billing cycle is the number of days between two statement generation dates. For instance, if the statement generation date is the 13th of every month, your billing cycle would be anywhere from 28 days to 31 days depending on the month.

  • Outstanding Balance

The outstanding balance is the amount that you owe your credit card issuer. It includes all the purchases made on your card, EMIs, interest and other charges. Your card issuer notifies you of the total outstanding balance at the end of every billing cycle. 

  • Interest

If you don’t pay your credit card bill in full by the due date, the card issuer will levy interest on the unpaid outstanding balance. The interest on the unpaid balance will continue to accrue till you clear it completely. 

  • Minimum Amount Due

The minimum amount due represents the minimum amount of money you need to pay by the due date to keep your card active. Usually, the minimum amount due would be 5% of the total outstanding balance plus EMIs, taxes, interest and other charges. 

  • Interest-Free Credit Period

The interest-free credit period is the number of days from the date of a transaction to the due date of payment. Depending on the transaction date, the interest-free credit period may vary from 20 days to 50 days. 

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How Credit Cards Transactions Work

When you transact with a merchant using a credit card, an entire payment system works behind the scenes. Here is a brief overview.

  • Authorisation: The merchant swipes your card in the PoS machine and you will be requested to enter the PIN. The credit card payment network checks whether you have sufficient balance and, if yes, the transaction is processed.

  • Batching: The merchant sends all the collected receipts to the acquirer bank to receive payments.

  • Clearance: The merchant’s bank requests approval from your bank on the payment network. Your bank then transfers the amount deducting the interface charges.

  • Funding: Finally, the acquirer bank credits the merchant’s bank account after deducting the merchant fee.

Working of a Credit Card for Online Transactions

Credit cards also allow you to pay for the purchase you make online, whether for products from e-commerce websites or e-services. When you proceed to check out or pay for any service, you need to follow the steps given below.

  • Enter card details like card number, expiry date, and CwVV

  • Select your card’s payments system (VISA, RuPay, or Mastercard), if required

  • Enter your name

  • When you click on the ‘Pay’ button, the bank will send you an OTP on your registered mobile number.

 

  • Enter and submit the OTP to authenticate the transaction

 

 

Note that payment gateways are also involved in the working of credit cards for online transactions. So, they also deduct a payment fee for facilitating the transfer of your card details from the merchant website to the payments network.  

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Where Can You Use Credit Cards?

Just like other cashless modes of payment, credit cards are widely accepted today. You can make credit card payments at the following:

  • Physical Store: You can use your credit card with a PoS machine at malls, high-end bakeries or retailers, or a tiny mom-and-pop store 

  • Online Payments: You can use your credit card when making any payment online for a product or service, whether shopping or booking tickets online.

 

In fact, you can make such payments using the Bajaj Finserv RBL Bank SuperCard available on Bajaj Markets. It allows you to convert the costs of your purchases into EMIs treated the same way in your credit card bill. 

 

Instead of the entire amount being billed upfront, you only have to pay the EMI amount on your credit card bill for a particular month. So, apply online and enjoy some of the best credit card offers in the market. 

What Happens When You Use a Credit Card for Payment?

The bank deducts the transaction amount from your overall credit card limit when you use a credit card for any transaction. As long as you are within your approved credit limit, you can make as many transactions as you want. 

 

At the end of each month, you will receive a credit card account statement for the purchases made.

What is a Credit Card APR? How Does Credit Card APR Work?

Annual Purchase Rate (APR) is the yearly charge you have to pay for borrowing money on your credit card. 

However, in most cases, you can avoid paying APR on your credit card. The bank foregoes APR if you clear all your credit card bills and outstanding balances by the stipulated due dates.

 

Your account balance determines the credit card APR. So, for instance, if your credit card balance is ₹1,000, the APR issued is 30%. If you fail to clear the balance on the due date, you will have to pay a total of ₹1,300 after a year. 

 

However, in case you have cleared all your credit card payments on time, you can close the balance at ₹1,000 only. You would not have to pay the APR charge. Issuer banks can charge different types of APRs on your credit card. These include:

  • Standard APR: Charged when you carry the balance from one month to another

  • Balance Transfer APR: Charged in case you opt for a balance transfer from an old credit card to a new one

  • Cash Advance APR: Charged when you borrow cash against your credit card

  • Penalty APR: Charged by the credit card issuer in case you fall behind your credit card dues

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What are Some of the Common Credit Card Fees?

Some of the common credit card fees that you might need to pay, include:

  • Annual Charges: Certain credit card issuers charge an annual fee every year to keep the credit card active. 

  • Late Payment Charges: These are the penalty charges when you fail to clear your credit card dues on time.

  • Foreign Transaction Fees: Certain credit card issuers charge a certain fee for transactions in foreign currency with your credit card. Generally, a forex mark-up of 1%-3% is charged, depending on the credit card issuer’s policies.

  • Cash Advance Fees: If you borrow cash against your credit card, the issuer might charge a cash advance fee.

  • Annual Percentage Rate: In case your balance is not paid in full by the due date, you are charged a certain annual percentage rate (APR) as interest. This APR might be fixed or flexible based on your credit card agreement.

  • Balance Transfer: When you transfer an outstanding payment from one credit card to another, the bank may charge you a balance transfer fee.

  • Over-limit charges: In case you exceed your balance over the stipulated credit limit, the credit card issuer will charge an over-limit fee.

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What is a Credit Card Statement?

To know how credit cards work, you must be familiar with credit card statements. A credit card statement summarises the transaction details of your card and provides the complete picture of your expenses for a particular bill cycle. 

 

This statement condenses the level of spending you are operating at for the particular billing period. The statement is an important piece of paper as it contains extensive details about your credit card usage, including the following:

1. Account Summary

The account summary is an overview of your credit card activity. All the payments and transactions you make during the billing cycle gets reflected here. 

 

Since this is the most important information anyone looks for in a credit card summary, it is usually the first section of the statement.

2. Other Sections Reflect:

  • Available Credit and Cash Limit

This refers to the proportion of the credit limit you exhausted in the previous cycle.

 

  • Minimum Payment Due

 

 

You must make the minimum payment against the total bill to keep your card active. It is usually 5% of the total outstanding. If not in full, you must pay your minimum due by the due date to avoid late payment charges.

 

  • Total Payment Due

 

 

This is the total outstanding due against your credit card. You start accruing interest if you do not pay your credit card bill in full each month.

 

  • Due Date

 

 

It is the last date to pay the minimum or total outstanding amount.

 

  • Interest and Fees Charged

 

 

The transaction summary also informs about any interest charges for late payments or fees for services and transactions. The idea is to disclose all information for your perusal.

 

  • Payment Methods

 

 

All the different modes of bill payment get reflected here. Depending upon your issuer, it will mention conventional options like cheque and draft or novel ones like mobile wallets, UPI payments, net banking, etc. 

 

In any case, make sure you do not overshoot the due date. If you are not able to do so, interest will add up to the outstanding amount. It will keep compounding until the repayment is made. So, the sooner you can repay, the better.

 

Credit cards are here to help you establish a credit history. Make sure you use them to your advantage. Delaying payments will negatively affect the credit history you aspire to build.

FAQs on How Credit Cards Work

How do the payments on a credit card work?

Credit cards allow you to spend money based on a pre-approved limit, which you must pay at the end of every billing cycle. You can avoid any interest or APR charges if you pay your credit card dues on time.

 

How does credit card processing work?

When you swipe the card at a PoS machine, the merchant bank requests your bank for approval on the card payments system. The transaction is processed if you have sufficient balance.

 

How do credit cards work technically?

When you make a payment, the merchant’s bank sends a request to your bank on the credit card payments network. The transaction is made to the merchant’s bank account if your bank approves the request.

 

How does a credit card work online?

While shopping online, you can make an online payment through a payment gateway. Enter your card details, and the OTP received on your registered mobile number to complete the transaction.

 

How should I use a credit card?

You should use your credit card carefully and prudently. Ensure that you limit your credit utilisation to around 30% of your total credit limit to avoid affecting your credit score adversely. Pay your outstanding dues in full within the due date, and do not limit your payments just to the minimum amount due.

How does credit card interest work?

Credit card interest is levied on the outstanding balance that remains to be paid after the due date. If you do not pay your dues in full within the due date, you will also have to pay interest on any new transactions that you make thereafter. This will continue till you settle all your  credit card dues.

 

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