How Do Credit Cards Work?

A Credit Card is an amazing convenience that lets you pay for your purchases online or offline without cash. Isn’t that what everybody wishes for? Sadly, it is not that simple.

Instead of giving you the full loan in cash, the card issuer lets you take as much of the credit limit as you want at a given time. As you pay off what you’ve borrowed, you can borrow again. For example, what makes a credit card different from a regular loan is that your credit limit is available after paying down the balance. Assuming you started with a zero balance, if you paid back the $75 that you owed by your credit card due date, in most cases, you’d have $300 of available credit again.

Let’s discuss how credit cards work in a step-by-step format:

  1. When you swipe your credit card to make a purchase, the merchant’s credit card terminal asks your credit card issuer whether the card is valid and has enough available credit.
  2. Afterwards, your credit card issuer sends a message in return, stating whether the transaction is approved or declined. If it’s approved, you’re good to go. If suppose, it gets declined, you may have hit your credit card limit or your card may have been deactivated due to suspected fraudulent activity. Fun fact: it doesn’t always mean that your identity has been stolen. Sometimes, card issuers may deactivate your card and get in touch if you’ve made unusual purchases. For instance, if you travel to a foreign country, your card issuer may deactivate your card until it confirms that you’re the one who made the purchases.
  3. You can keep borrowing against your credit card limit over time. This is the reason credit cards are popularly called revolving accounts or open-ended accounts.
  4. The credit card issuer gives you a specific period of time to pay back the credit that you’ve borrowed before the issuer starts charging interest. The period of time before the interest is charged is called the grace period which is typically between 21 and 25 days.
  5. If you fail to return the amount by the deadline, a finance charge is added to your balance. The finance charge is based on your interest rate and outstanding balance. All in all, if you want to avoid the extra charges, all you have to do is simply pay the borrowed amount within the grace period!

What is the difference between a Credit cards and Debit cards?

The major dichotomy that lies between credit and debit cards is that credit cards allow you to borrow against credit line whereas, debit cards only allow you to electronically deduct purchases from your checking account. You may have to enter your billing ZIP code to make a purchase with your credit card. But you just need to enter your pin while purchasing with your debit card.

That’s all for this topic. Also, check out how money works? Let us know what you think about it in the comment section!


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