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Credit Cards
How do credit cards work?
Credit cards are almost always issued by banks. An agreement is made between the
issuer of the credit card (bank/credit provider) and the card holder, of a
pre-set credit limit. The user is then enabled to make purchases up to the
credit limit provided. However, the agreement states that the card user must pay
back the card issuer.
When a credit card is used to make a purchase, the card holder signs a receipt
which will show all of the details of the card used. By signing a receipt, or
more commonly these days, entering a PIN number, the card holder is indicating
their complete consent to pay.
How are credit cards and credit limits verified?
Credit cards are verified using electronic verification systems, of which all
merchants that offer credit card facilities will have. This system checks the
validity of the customer’s credit card and whether or not they have enough
credit on their card to cover their purchase. Verification is carried out
through a Point of Sale system which has a direct link to the merchant’s bank.
The credit card releases its information through the magnetic strip on the card.
This system is known as Chip and Pin within the UK.
Often a purchase is made over the telephone or through the internet. In this
situation the merchant does not have access to the magnetic strip on the card as
the customer is not present. Therefore in this situation other verification
variations are needed such as the customer/cardholder providing extra
information such as address, telephone number, or part of the security code
located on the reverse side of the card.
Keeping track of balance and charges
All purchases and charges made to the card holder’s account are sent to them,
usually on a monthly basis, in the form of a statement. This lists all action on
the account throughout the month, including dates and times of transactions. The
next step is for the credit card holder to either pay a minimum payment by a
certain date, all details of which will be found on the statement, or pay off
the full amount owed. This is the best method as card issuers often waive any
interest charges if the amount is paid off in full every month. However, if this
is not the case and the card holder simply meets their minimum payment, interest
is charged on the debt that is owed in the account. Standing orders and direct
debits can usually be set up with your bank to automatically take out a minimum
payment in time for the due date.
How is interest calculated?
As stated above, interest is charged by the card issuer on any outstanding debt
on the credit card account. Interest is charged from immediately after the
purchase is made, and continues to be so until the debt is cleared.
There is a formula used by the institutions to work out interest charges:
APR/100 x ADB/365 x number of days revolved. This means you take the annual
percentage rate (APR) and divide it by 100. This is then multiplied by the
average daily balance (ADB) divided by 365. This number is then multiplied by
the total number of days the amount revolved before payment was made on the card
holder’s account.
Despite this formula, interest rates can vary significantly from credit card to
credit card. For example an interest rate may rise considerably if the card
holder makes a late payment on the credit card account or any other credit
instrument. It can also rise if the bank who has issued the card decides to
increase its revenue. Due to varying rates and terms, services have been made
available to make savings by switching credit cards to try and always get the
lowest and best rates available.
Is there one better card than another?
The answer to this is not necessarily. Due to fierce competition between credit
card companies for your custom, certain incentives and deals are often offered.
For example they may offer you cash back or gift vouchers if you sign up to
their particular company. However, 0% interest and other low interest credit
cards are available and these would be the better cards to apply for. The bad
news is that this low interest deal is often confined to a set period of time (6
months – 1 year), and then a higher rate is then applied to the account. As
mentioned above, services have been made available to switch between the credit
card companies in order to always have the best rate possible.
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