What is Credit Card and How do They Work?

When everything is turning digital, managing one’s finances solely on cash is nothing but an outdated idea. And with increasing expenditure on healthcare and education, the need for credit is evident now more than ever. A credit card serves just that – an increase in one’s purchasing power and flexibility in finances. 

What is Credit Card? - Meaning

If we go by the credit card definition, a credit card is a plastic or metal card that financial institutions, typically a bank, issue to eligible customers. It comes with a pre-determined limit. While purchasing, instead of paying right away, a credit card enables the cardholder to purchase the goods/services now and pay later. 

 Benefits of Credit Card

1. Provides financial flexibility

A credit above all provides customers with financial flexibility. For instance, you might need a new mobile phone right now, but your monthly budget isn’t allowing that until next month. Now, if you have a credit card limit, say Rs. 1 lakh, you can easily purchase a new mobile phone right away using your credit card while paying for it later, but with interest.

2. Helps build one’s credit history

Using a credit card exposes you to the credit market, which directly results in changes in your credit score. What is a credit score, you ask? Well, a credit score is your creditworthiness, i.e. how reliable you are for the banks to lend you money. If you use a credit card and make timely payments, your credit score will likely improve. This will help you get a personal loan, home, loan, etc., at an easier pace.

3. Access to exclusive membership rewards

When you use a credit card to make a purchase, you earn reward points on it. Upon accumulating enough rewards points, you get a chance to redeem these points on various member-only offers on travel, dining, shopping, etc. Therefore, every time you buy something using your credit card, you automatically smooth out things for your next purchase as well.

4. Makes for a safe purchase trail

Many times it happens that you buy something in cash, and the receipt gets lost. In such cases, having access to your purchase’s after-sale services may get difficult. Now, if the payment was made using a credit card, one can easily access the purchase details. But, unfortunately, it may facilitate getting a duplicate receipt too. 

5. Safety against online fraud/theft

If your credit card gets stolen or lost and you block and report your card instantly, nobody would be able to use it for any kind of transaction. However, if you get to know of your card theft sometime later, you can also report it, and the amount thus deducted from your limit shall be treated as an unauthorized transaction. 

Use of Credit Cards in India

Credit card is a fairly new concept in India. Since the last few years, there has been an increase in the penetration of credit card users in the market. However, the use is not judicial yet, which is due to a lack of credit knowledge.

Some of the problems seen are:

The payment of minimum due amount only: Due to the lack of awareness, people start treating credit card bill like an EMI. This leads to added interests and finance charges. 

Overuse of credit card: Many a time, people end up taking a personal loan just to pay their credit card bills. This nullifies the idea of a credit card and harms users more than it benefits. 

Types of Credit Cards

A credit card can be classified as follows: 

1. Purchase-specific cards: There are usually three types of purchase-specific cards, viz.:

Travel cards – Offers discounts and deals on airline tickets and railways. Some cards may also run offers on bus bookings made on specific platforms like Red Bus, etc. Along with benefits on tickets, some cards may provide complimentary access to VIP lounges. 

Dining Cards – These cards can be best friends with those who love food, especially dine-out. Such credit cards are tailor-made to allow customers to enjoy benefits like complimentary drinks, 1+1 meals, discounts and reward points on dining transactions. 

Shopping Cards – As the name suggests, shopping credit cards are designed to offer the best deals when one wishes to shop online or at a store. This helps you save significantly on your shopping.

2. Reward/Cashback Cards – A cashback or rewards special credit card is perfect for those who often spend. This is because, on every transaction made (T&Cs applied), you get to collect reward points and/or cashback. When a certain reward point number is reached, these can be redeemed to make a purchase.

3. Zero Annual Fee Cards or Zero APR – Most credit cards come with a fixed annual fee (usually ranging from Rs. 500 – Rs. 2000) charged from the cardholder, irrespective of their credit history. Usually, a credit card with greater benefits charges a high annual fee and vice-versa. These rewards and benefits are offered to you only if you use your credit card to a certain limit or regularly. 

4. Secured cards – All the above-stated cards come under the category of unsecured credit cards. A secure credit card is issued against your fixed deposit. The limit provided can go up to 90% of the FD amount, and the charges are also minimal. Such cards fetch a low interest and annual fee as compared to an unsecured credit card. 

How Do Credit Cards Work?

The working of a credit card is very simple and, thus, easy to understand. Let’s understand it with the help of an example: 

Mr H has a Citibank credit card with a limit of Rs. 1 lakh. He uses it to buy a mobile phone worth Rs. 40,000 on 4th April ’21 via this credit card. His revised credit limit is Rs. 60,000 now. On 20th April ’21, Mr A makes bill payments worth Rs. 5,000. Now his new credit limit is revised to Rs. 55,000.  

Case 1: Makes full payment

On the due date (e.g. 11th of next month), he pays the total bill of Rs. 55,000 in full. The bank does not incur any finance charges on this payment. His credit limit is revised to Rs. 1 lakh again.

Case 2: Makes part-payment

On the due date (e.g. 11th of next month), he pays a minimum bill of Rs. 10,000. There was no charges or penalties levied on this amount. However, now, after the due date, the remaining amount of Rs. 35,000 (45,000 – 10,000) starts luring interest plus finance charges on it. This is continued every month till the total amount is not paid in full. 

Credit cards can be used online as well as offline. 

On online portals, you need to provide the following details at a secure payment gateway: 

· Cardholder name

· Card number 

· Expiry date (MM/YY)

· CVV

· OTP (sent to your linked mobile number)

For offline shopping, you just need to swipe your card at the POS machine and provide your PIN. Upon successful transaction, an email/SMS shall be sent to you by your card provider as a confirmation.

Credit Card vs Debit Card

The following are the basic differences between a credit card and a debit card:  

 Key Takeaways/Conclusion

Where a credit card enables one to manage their finances better by providing flexibility and enhanced purchasing power, it can also put a naïve user in a vicious debt cycle. Therefore, it is very important to keep the following points in mind if you’re a credit card user: 

• Use only that much which you can easily pay 
• Try to limit your credit utilization ratio to 30% (if the limit is Rs. 1 lakh, do not go beyond Rs. 30,000) – This helps in a good credit score while helps in getting a loan easily in future
• Try to pay your credit card bill in full, if not at least pay the minimum amount due 
• Do not use your credit card on public networks (like cafes, etc.)
• Check your reward points and redeem the same as and when you can 
• Do not close your credit accounts randomly if you have more than one (this may increase your credit utilization ratio)

Frequently Asked Questions (FAQs)

✅What is the full form of APR?

The full form of APR is the Average Percentage Rate. It is the rate at which you’re charged the entire year. E.g. if your APR is 12%, it means that you are charged 1 % every month. In other words, you will pay 1% of the balance amount you carry forward every month. 

✅What is CVV in a credit card?

CVV is the Card Verification Value. CVV is a 3-digit number, which is printed on the backside of your credit card, without which authentication cannot be done for online transactions. You should never share your CVV with anyone. It may lead to online frauds. 

✅How does a credit card work?

A credit card is issued with a credit limit basis various factors like your age, credit history, the credit score (usually above 700 is considered), employment type (salaried people get a credit card easily than non-salaried ones), etc. As you use your credit card, the limit reduces by the purchase amount. Then, when you pay your card bill, the credit limit revises back. 

✅What is the meaning of a credit card? What type of payment is this?

A credit card is a rectangular thin plastic or metal card with 16 digits printed or etched on it. It also has an expiration date mentioned on it, along with a CVV and other important details. It can either be swiped or touched at a POS machine or used to make online transactions. 

✅How is a credit card different than debit card?

A debit card allows the transfer of funds from the linked bank account immediately to the merchant’s account. A credit card payment is made by deducting the transaction amount from the assigned credit limit and paid to the merchant. This amount is to be paid by the cardholder later with interest.