A credit card is a small plastic card issued to users as a system of payment. It allows its holder to buy goods and services based on the holder's promise to pay for these goods and services. The issuer of the card creates a revolving account and grants a line of credit to the consumer (or the user) from which the user can borrow money for payment to a merchant or as a cash advance to the user.
A credit card is different from a charge card: a charge card requires the balance to be paid in full each month. In contrast, credit cards allow the consumers a continuing balance of debt, subject to interest being charged. Most credit cards are issued by banks or credit unions, and are the shape and size specified by the ISO/IEC 7810 standard as ID-1. This is defined as 85.60 × 53.98 mm (3.370 × 2.125 in) (33/8 × 21/8 in) in size.
History
The concept of using a card for purchases was described in 1887 by Edward Bellamy in his utopian novel Looking Backward. Bellamy used the term credit card eleven times in this novel.
The modern credit card was the successor of a variety of merchant credit schemes. It was first used in the 1920s, in the United States, specifically to sell fuel to a growing number of automobile owners. In 1938 several companies started to accept each other's cards. Western Union had begun issuing charge cards to its frequent customers in 1921. Some charge cards were printed on paper card stock, but were easily counterfeited.
The Charga-Plate was an early predecessor to the credit card and used in the U.S. from the 1930s to the late 1950s. It was a 2½" × 1¼" rectangle of sheet metal, similar to a military dog tag, and embossed with the customer's name, city and state. It held a small paper card for a signature. In recording a purchase, the plate was laid into a recess in the imprinter, with a paper "charge slip" positioned on top of it. The record of the transaction included an impression of the embossed information, made by the imprinter pressing an inked ribbon against the charge slip.[3] Charga-Plate was a trademark of Farrington Manufacturing Co. Charga-Plates were issued by large-scale merchants to their regular customers, much like department store credit cards of today. In some cases, the plates were kept in the issuing store rather than held by customers. When an authorized user made a purchase, a clerk retrieved the plate from the store's files and then processed the purchase. Charga-Plates speeded back-office bookkeeping that was done manually in paper ledgers in each store, before computers.
The concept of customers paying different merchants using the same card was implemented in 1950 by Ralph Schneider and Frank McNamara, founders of Diners Club, to consolidate multiple cards. The Diners Club, which was created partially through a merger with Dine and Sign, produced the first "general purpose" charge card, and required the entire bill to be paid with each statement. That was followed by Carte Blanche and in 1958 by American Express which created a worldwide credit card network (although these were initially charge cards that acquired credit card features after BankAmericard demonstrated the feasibility of the concept).
However, until 1958, no one had been able to create a working revolving credit financial instrument issued by a third-party bank that was generally accepted by a large number of merchants (as opposed to merchant-issued revolving cards accepted by only a few merchants). A dozen experiments by small American banks had been attempted (and had failed). In September 1958, Bank of America launched the BankAmericard in Fresno, California. BankAmericard became the first successful recognizably modern credit card (although it underwent a troubled gestation during which its creator resigned), and with its overseas affiliates, eventually evolved into the Visa system. In 1966, the ancestor of MasterCard was born when a group of California banks established Master Charge to compete with BankAmericard; it received a significant boost when Citibank merged its proprietary Everything Card (launched in 1967) into Master Charge in 1969.
Early credit cards in the U.S., of which BankAmericard was the most prominent example, were mass produced and mass mailed to bank customers who were thought to be good credit risks; that is, they were unsolicited. These mass mailings were known as "drops" in banking terminology, and were outlawed in 1970 due to the financial chaos that they caused, but not before 100 million credit cards had been dropped into the U.S. population. After 1970, only credit card applications could be sent unsolicited in mass mailings.
The fractured nature of the U.S. banking system under the Glass-Steagall Act meant that credit cards became an effective way for those who were traveling around the country to move their credit to places where they could not directly use their banking facilities. In 1966 Barclaycard in the UK launched the first credit card outside of the U.S.
There are now countless variations on the basic concept of revolving credit for individuals (as issued by banks and honored by a network of financial institutions), including organization-branded credit cards, corporate-user credit cards, store cards and so on.
Although credit cards reached very high adoption levels in the US, Canada and the UK in the mid twentieth century, many cultures were more cash-oriented, or developed alternative forms of cash-less payments, such as Carte bleue or the Eurocard (Germany, France, Switzerland, and others). In these places, adoption of credit cards was initially much slower. It took until the 1990s to reach anything like the percentage market-penetration levels achieved in the US, Canada, or UK. In some countries, acceptance still remains poor as the use of a credit card system depends on the banking system being perceived as reliable. Japan remains a very cash oriented society, with credit card adoption being limited to only the largest of merchants, although an alternative system based on RFIDs inside cellphones has seen some acceptance. Because of strict regulations regarding banking system overdrafts, some countries, France in particular, were much faster to develop and adopt chip-based credit cards which are now seen as major anti-fraud credit devices. Debit cards and online banking are used more widely than credit cards in some countries.
The design of the credit card itself has become a major selling point in recent years. The value of the card to the issuer is often related to the customer's usage of the card, or to the customer's financial worth. This has led to the rise of Co-Brand and Affinity cards - where the card design is related to the "affinity" (a university or professional society, for example) leading to higher card usage. In most cases a percentage of the value of the card is returned to the affinity group.
A growing field of numismatics (study of money), or more specifically exonumia (study of money-like objects), credit card collectors seek to collect various embodiments of credit from the now familiar plastic cards to older paper merchant cards, and even metal tokens that were accepted as merchant credit cards. Early credit cards were made of celluloid plastic, then metal and fiber, then paper, and are now mostly plastic.
How credit cards work
Credit cards are issued after an account has been approved by the credit provider, after which cardholders can use it to make purchases at merchants accepting that card. Merchants often advertise which cards they accept by displaying acceptance marks – generally derived from logos – or may communicate this orally, as in "Credit cards are fine" (implicitly meaning "major brands"), "We take (brands X, Y, and Z)", or "We don't take credit cards".
When a purchase is made, the credit card user agrees to pay the card issuer. The cardholder indicates 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). Also, many merchants now accept verbal authorizations via telephone and electronic authorization using the Internet, known as a card not present transaction (CNP).
Electronic verification systems allow merchants to verify in a few seconds that the card is valid and the credit card customer has sufficient credit to cover the purchase, 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 called Chip and PIN in the United Kingdom and Ireland, and is implemented as an EMV card.
For card not present transactions where the card is not shown (e.g., e-commerce, mail order, and telephone sales), merchants additionally verify that the customer is in physical possession of the card and is the authorised user by asking for additional information such as the security code printed on the back of the card, date of expiry, and billing address.
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 (see Fair Credit Billing Act for details of the US regulations). 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 issuer charges interest on the amount owed if the balance is not paid in full (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.
Advertising, solicitation, application and approval
Credit card advertising regulations include the Schumer box disclosure requirements. A large fraction of junk mail consists of credit card offers created from lists provided by the major credit reporting agencies. In the United States, the three major US credit bureaus (Equifax, TransUnion and Experian) allow consumers to opt out from related credit card solicitation offers via its Opt Out Pre Screen program.
Interest charges
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.
For example, if a user had a $1,000 transaction and repaid it in full within this grace period, there would be no interest charged. If, however, even $1.00 of the total amount remained unpaid, interest would be charged on the $1,000 from the date of purchase until the payment is received. The precise manner in which interest is charged is usually detailed in a cardholder agreement which may be summarized on the back of the monthly statement. 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. Financial institutions refer to interest charged back to the original time of the transaction and up to the time a payment was made, if not in full, as RRFC or residual retail finance charge. Thus after an amount has revolved and a payment has been made, the user of the card will still receive interest charges on their statement after paying the next statement in full (in fact the statement may only have a charge for interest that collected up until the date the full balance was paid, i.e. when the balance stopped revolving).
The credit card may simply serve as a form of revolving credit, or it may become a complicated financial instrument with multiple balance segments each at a different interest rate, possibly with a single umbrella credit limit, or with separate credit limits applicable to the various balance segments. Usually this compartmentalization is the result of special incentive offers from the issuing bank, to encourage balance transfers from cards of other issuers. In the event that several interest rates apply to various balance segments, payment allocation is generally at the discretion of the issuing bank, and payments will therefore usually be allocated towards the lowest rate balances until paid in full before any money is paid towards higher rate balances. Interest rates can vary considerably from card to card, and the interest rate on a particular card may jump dramatically if the card user is late with a payment on that card or any other credit instrument, or even if the issuing bank decides to raise its revenue.
Benefits to customersThe main benefit to each customer is convenience. Compared to debit cards and cheques, a credit card allows small short-term loans to be quickly made to a customer who need not calculate a balance remaining before every transaction, provided the total charges do not exceed the maximum credit line for the card. Credit cards also provide more fraud protection than debit cards. In the UK for example, the bank is jointly liable with the merchant for purchases of defective products over £100.
High interest and bankruptcy
Low introductory credit card rates are limited to a fixed term, usually between 6 and 12 months, after which a higher rate is charged. As all credit cards charge fees and interest, some customers become so indebted to their credit card provider that they are driven to bankruptcy. Some credit cards often levy a rate of 20 to 30 percent after a payment is missed; in other cases a fixed charge is levied without change to the interest rate. In some cases universal default may apply: the high default rate is applied to a card in good standing by missing a payment on an unrelated account from the same provider. This can lead to a snowball effect in which the consumer is drowned by unexpectedly high interest rates. Further most card holder agreements enable the issuer to arbitrarily raise the interest rate for any reason they see fit.
Inflated pricing for all consumers
Merchants that accept credit cards must pay interchange fees and discount fees on all credit-card transactions. In some cases merchants are barred by their credit agreements from passing these fees directly to credit card customers, or from setting a minimum transaction amount. The result, at least in the United States, is that merchants may charge all customers (including those who do not use credit cards) higher prices to cover the fees on credit card transactions. In the United States in 2008 credit card companies collected a total of $48 billion in interchange fees, or an average of $427 per family, with an average fee rate of about 2% per transaction.
A credit card's grace period is the time the customer has to pay the balance before interest is assessed on the outstanding balance. Grace periods vary, but usually range from 20 to 50 days depending on the type of credit card and the issuing bank. Some policies allow for reinstatement after certain conditions are met.
Usually, if a customer is late paying the balance, finance charges will be calculated and the grace period does not apply. Finance charges incurred depend on the grace period and balance; with most credit cards there is no grace period if there is any outstanding balance from the previous billing cycle or statement (i.e. interest is applied on both the previous balance and new transactions). However, there are some credit cards that will only apply finance charge on the previous or old balance, excluding new transactions.
Benefits to merchants
An example of street markets accepting credit cards. Most simply display the acceptance marks (stylized logos, shown in the upper-left corner of the sign) of all the cards they accept.For merchants, a credit card transaction is often more secure than other forms of payment, such as cheques, because the issuing bank commits to pay the merchant the moment the transaction is authorized, regardless of whether the consumer defaults on the credit card payment (except for legitimate disputes, which are discussed below, and can result in charges back to the merchant). In most cases, cards are even more secure than cash, because they discourage theft by the merchant's employees and reduce the amount of cash on the premises.
Prior to credit cards, each merchant had to evaluate each customer's credit history before extending credit. That task is now performed by the banks which assume the credit risk. Credit cards can also aid in securing a sale, especially if the customer does not have enough cash on his or her person or checking account. Extra turnover is generated by the fact that the customer can purchase goods and/or services immediately and is less inhibited by the amount of cash in his or her pocket and the immediate state of his or her bank balance. Much of merchants' marketing is based on this immediacy.
For each purchase, the bank charges the merchant a commission (discount fee) for this service and there may be a certain delay before the agreed payment is received by the merchant. The commission is often a percentage of the transaction amount, plus a fixed fee (interchange rate). In addition, a merchant may be penalized or have their ability to receive payment using that credit card restricted if there are too many cancellations or reversals of charges as a result of disputes. Some small merchants require credit purchases to have a minimum amount to compensate for the transaction costs.
In some countries, for example the Nordic countries, banks guarantee payment on stolen cards only if an ID card is checked and the ID card number/civic registration number is written down on the receipt together with the signature. In these countries merchants therefore usually ask for ID. Non-Nordic citizens, who are unlikely to possess a Nordic ID card or driving license, will instead have to show their passport, and the passport number will be written down on the receipt, sometimes together with other information. Some shops use the card's PIN for identification, and in that case showing an ID card is not necessary.
Costs to merchants
Merchants are charged several fees for the privilege of accepting credit cards. The merchant is usually charged a commission of around 1 to 3 per-cent of the value of each transaction paid for by credit card. The merchant may also pay a variable charge, called an interchange rate, for each transaction. In some instances of very low-value transactions, use of credit cards will significantly reduce the profit margin or cause the merchant to lose money on the transaction. Merchants must accept these transactions as part of their costs to retain the right to accept credit card transactions. Merchants with very low average transaction prices or very high average transaction prices are more averse to accepting credit cards. In some cases merchants may charge users a "credit card supplement", either a fixed amount or a percentage, for payment by credit card.
In certain countries, merchants are required to pay the acquiring banks a monthly terminal rental fee if the terminals are provided by the acquiring banks. Merchants can apply to the acquiring banks for waivers of the fees, which the banks usually agree to for merchants with a high volume of sales
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