What is a Credit Card?

Credit cards are small plastic cards issued to the customers of companies who provide credit. A credit card is different from a debit card. Rather than remove money from the user's account after every transaction, credit cards lend money to the user to be paid to the merchant when a purchase is made.

Credit cards allow the consumer to spend money they do not have at the cost of having interest charged. Most credit cards are the same shape and size as specified by the ISO 7810 standard. The most common credit card size, known as ID-1, is 85.60 × 53.98 mm.

How do Credit Cards Work?

When a member of the public applies for a credit card they sign a contract with a credit provider. In this they agree to pay their credit card issuer whenever they use their credit card to make a purchase. 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 Personal identification number (PIN). Many merchants now also accept verbal authorizations via telephone and electronic authorization using the Internet, known as a 'Card/Cardholder 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.

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. 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 bank accounts, thus avoiding late payment altogether as long as the cardholder has sufficient funds.

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.

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 (ADB) 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.

Because of intense competition in the credit card industry, credit providers often offer incentives such as frequent flyer points, gift certificates, or cash back (typically up to 1 percent based on total purchases) to try to attract customers.

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.