Credit Cards as a Means of Payment

Moving Money Between Banks is Not As Simple as it May Seem

In order for someone to use a credit card to pay for something, the person offering the goods or services for sale must first take the credit card as payment, which means that they must have a prior arrangement set up with the issuer of the credit card to allow for funds to be sent to them.

Credit Cards as a Means of PaymentIf this is not the case, then it’s not going to be possible to use the credit card to make the desired purchase with the particular credit card that the purchaser is seeking to use. There are instances where this does indeed arise, where someone is looking to use a certain credit card with a merchant and the merchant does not accept it, because they have not set up the means to do so.

So that is the first step in the process, and if merchants had to set up individual relationships out there with each credit card offered by all the banks out there, then the process would be very tedious, since there are a lot of different credit cards out there. This would be especially troublesome if the credit card is issued by a bank in another country, as international interbank payments are particularly challenging due to the fact that there aren’t preexisting arrangements set up between them generally.

So you have money in a certain bank and the goal is to get this money ultimately into the merchant’s bank, but the banks don’t deal with each other directly as a general rule, although this does differ by country and some countries have a system in place where one can arrange for interbank payments fairly easily.

In most countries though there are limited options and often you have to resort to a wire transfer even for domestic bank to bank transfers, which is not only expensive but takes several days even for a confirmation, and you can’t do anything until the payment clears.

This isn’t what people are after with point of sale purchases though, as they would not even be possible, as it’s necessary to have the payment confirmed immediately for the merchant to release what you’re buying to you, or a bank machine to release cash if that’s what you’re seeking to do with your card.

The Role of Networks With Credit Card Payments

This applies to both credit and debit cards, and this is why it’s both practical and necessary to have these payments processed by a third party processor, who will set up a network to facilitate the transfer of funds necessary to make non cash point of sale payments possible.

During the dawn of the era of major credit cards, banks used to offer their own independent cards, for instance the BankAmericard which was initially just issued by a single bank, Bank of America. Soon, many merchants started taking the BankAmericard, and other banks wanted in on this but either didn’t have the means to take on a project like this or just wanted to leverage the success of this card, so they banded forces with BankAmericard.

So more and more banks started issuing BankAmericards and this eventually grew to become what we now know as Visa, which is now a worldwide operation and the world’s most popular credit card payment processor.

So now, all you need is the merchant to take Visa as a payment method, and it doesn’t matter what bank the card is issued by, or what country it is issued in, as Visa will process the payments between you and the merchant’s bank seamlessly.

Master Charge was set up a few years after the success of Visa, as an alternative to it, and many banks joined in on this effort, which is known today as MasterCard, in second place worldwide. American Express has also been around since the early days of major credit cards and while American Express credit cards are not quite as widely accepted as Visa or MasterCard, enough merchants do accept it to allow them to maintain third place in the global credit card marketplace.

That’s really what it’s all about with these networks, acceptance rate, as if you can’t use your credit card where you want to use it then that can be a real issue for cardholders. This is particularly the case with credit cards, as often it’s not a matter of their being able to pay in cash as an alternative payment method, because they may not be carrying or even have the cash to their name at the time, as they may want to or need to use credit for the transaction, and the utility of the credit card will depend fundamentally on its ease of use and its acceptance rate.

Merchant issued cards of course will be accepted by the issuing merchant, but only by the merchant, and having a card that is accepted by most merchants worldwide is a big benefit, especially in other countries where your debit cards won’t work, and if you want to use cash you are going to have to carry foreign currency. Major credit cards make this all very easy as one card can buy you virtually anything, virtually anywhere, including in the online world.

How Credit Card Payments Work

Credit card payments are not instant, like they seem to be, but instead involve a promise to pay someone for something. It’s important to the merchant that you have the means to pay for it though, and this is what the authorization process accomplishes.

In the early days of credit cards, before electronic transactions, it used to be necessary to place a phone call to the credit card company to receive authorization. The credit card company would check the cardholder’s available credit balance to ensure that the purchase was within that parameter, provide an authorization code, and then deduct the purchase amount from the credit balance.

Since credit is involved with a credit card, card issuers want to be aware of the level of borrowing, and will assign various limits to each cardholder. Since the payment will be made by the credit card issuer and not the cardholder, with the issuer loaning the cardholder the money to be paid back at a later date, placing a limit on the maximum amount that may be borrowed at any one time is necessary, as it is in all lending situations, to ensure the borrower has the capacity to repay the loans.

With debit cards, there are limits as well, but in this case the payments are being made by the debit cardholders out of their bank accounts, which may include paying from deposits or from credit products, but in all cases there are limits involved, how much money one has in the account they are using or their available credit if it’s an account that allows borrowing, a bank account with overdraft for instance or a revolving line of credit.

All credit cards are revolving lines of credit by nature though, and therefore the credit limit is going to determine whether they are approved or not.

Nowadays it’s all done electronically, which includes an inquiry into the credit limit of the cardholder as well as any security issues that may cause the transaction to be declined, for instance purchases that the card issuer’s software may find to be suspicious.

This is why it’s a good idea to notify the issuer of your credit card if you are going to be using your card outside the country, as otherwise they may block a foreign transaction out of a concern that the card may be used fraudulently.

Once the purchase becomes authorized, the transaction is added to the pending list of your credit card account, which counts against your available credit while it is waiting to be processed. Credit card payments, like debit transactions and bank transactions generally, are processed in bulk at the end of every business day, for the sake of efficiency.

So the credit card company will arrange for a certain amount of money to be paid to the merchant’s bank and then the funds will be transferred, which takes another day generally as the banks process these payments at the end of the business day in bulk too, and this is why purchases are instant but take a couple of business days generally to be completed and posted to your credit card statement. Some banks allow cardholders to view their pending payments in real time online though, which is a very useful feature to keep track of your usage.

Credit card companies discount the payments that they make to merchants by adding in a processing fee, which differs by credit card and merchant, and is arranged in each merchant’s agreement with each of the major credit card companies.

While these processing fees are significantly higher than what it costs to process debit transactions, if a merchant does not accept a certain card, especially Visa or MasterCard, then this will impact their business so a mutually satisfactory arrangement is almost always made.

The cardholder will arrange to pay back the borrowed funds, and if they do so within the grace period, no interest will be charged on purchases, as the credit card issuer is already making money on these purchases by way of the processing fees they collect such that they are willing to waive interest charges if the account is kept up to date.

This involves paying off the previous statement balance in full during the current statement period, which is something that a lot of cardholders aren’t clear on, it doesn’t ever involve bringing your balance to zero for instance, but it does mean that you pay off last month’s purchases in full this month.

So if your closing balance was $1000 last month, you need to make at least $1000 in payments this month, and that’s the easiest way to approach this, otherwise this can end up being pretty confusing to people. If you don’t manage this, you will pay interest on all your purchases on the card from the time of purchase to the time the amount is paid, as in this case they are extending you more than just short term credit which involves more risk to them.

Credit cards are a great way to make purchases, especially since many cards offer reward programs, so if you handle this right, you get to borrow the money for a short time and they pay you to do it instead of you paying them.

Ken Stephens

Chief Editor,

Ken has a way of making even the most complex of ideas in finance simple enough to understand by all and looks to take every topic to a higher level.

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