A credit card system is a type of retail transaction settlement and credit system, named after the small plastic card issued to users of the system. A credit card is different from a debit card in that the credit card issuer lends the consumer money rather than having the money removed from an account. It is also different from a charge card (though this name is often used to describe credit cards by the public) in that charge cards do not extend the user credit -- the charges must be paid each month in full. Most credit cards are the same shape and size, as specified by the ISO 7810 standard.
How they work
A credit card user is issued the card after approval from a provider (often a general bank, but sometimes from a captive bank created to issue a particular brand of credit card, such as American Express Centurion Bank), in which they will be able to make purchases from merchants supporting that credit card up to a prenegotiated credit limit. When a purchase is made, the credit card user indicates his/her consent to pay, usually by signing a receipt with a record of the card details and indicating the amount to be paid. More recently, electronic verification systems have allowed merchants (using a strip of magnetized material on the card holding information in a similar manner to magnetic tape or a floppy disk) to verify that the card is valid and the credit card customer has sufficient credit to cover the purchase in a few seconds, allowing the verification to happen at time of purchase. Some services can be paid for over the telephone by credit card merely by quoting the number embossed onto the card (the credit card number), and they can be used in a similar manner to pay for purchases from online vendors.
Each month, the credit card user is sent a statement indicating the purchases undertaken with the card, and the total amount owing. The cardholder must then pay a minimum proportion of the bill by a due date, and may choose to pay more or indeed pay the entire amount owing. The credit provider charges interest on the amount owing (typically, a fairly high rate much higher than most other forms of debt). Typically, credit card issuers will waive interest charges if the balance is paid in full each month, which allows the credit card to serve as a form of revolving credit. Interest rates can vary considerably from card to card, and the interest rate on a particular card may jump dramatically if you're late with a payment on that card or any other credit instrument. You can calculate the savings with a lower-interest credit card (http://www.low-interest-rate-credit-card-offers.com/calculator.htm); if you have a large balance, those savings can be considerable.
As well as profits through interest, card companies charge merchants fees for money transfer. When the companies formally or informally prevent these fees from being passed on to credit card users but instead require them to be spread among all customers, this raises the possibility of a harmful market imperfection through the mechanism of the Tragedy of the commons, especially as some credit providers give their users incentives such as frequent flier miles or gift certificates. Australia is currently acting to reduce this by allowing merchants to apply surcharges for credit card users. Credit card companies generally do provide a guarantee the merchant will be paid on legitimate transactions regardless of whether the consumer pays their credit card bill. However, credit card companies generally will not pay a merchant if the consumer challenges the legitimacy of the transaction and will fine merchants who have a large number of chargebacks.
The credit card was the successor of a variety of merchant credit schemes. The concept of paying merchants using a card was invented in 1950 with Diners Club's invention of the charge card, which is similar but required the entire bill to be paid with each statement. Credit card service was first offered in 1951.
In recent times, credit card portfolios have been exceedingly profitable to banks, largely due to the booming economy of the late nineties. However in the case of credit cards, such high returns go hand in hand with risk.
Secured credit cards
A secured credit card is a special type of credit card in which you must first put down a deposit between 100% and 150% of the total amount of credit you desire. Thus if you put down $1000, you will be given credit in the range of $500–$1000. This deposit is held in a special savings account. The owner of the secured credit card is still expected to make regular payment, as he or she would with a regular credit card, but should he or she default on a payment, the card issuer can deduct payments on the card out of the deposit. Secure credit cards are an advantage to anyone with poor or no credit history. They are often offered to people as a means of rebuilding one's credit. Secured credit cards are available with both Visa and MasterCard logos on them.
As well as convenient, accessible credit, the cards offered consumers an easy way to track expenses, which is necessary both for monitoring personal expenditure and the tracking of work-related expenses for taxation and reimbursement purposes. They have now spread worldwide, and are offered in a huge variety of permutations with differing credit limits, repayment arrangements (some cards offer interest-free periods, while others do not but compensate with much lower interest rates), and other perks (such as rewards schemes in which points "earned" for purchasing goods with the card can be reclaimed for further goods and services).
In addition, some countries such as the United States limit the amount that a consumer can be held liable for fraudulent transactions, which shifts the liability to the merchant. This encourages the use of credit cards for electronic and mail order transactions, collectively called "card not present" transactions. For further security, some banks are offering one-time numbers for use in these transactions. They have spread far and wide beyond their initial market of the wealthy businessman and are now ubiquitous amongst the middle class of most Western countries.
The relatively low security of the credit card system presents many opportunities for fraud. However, this does not imply that the system is broken. The goal of the credit card companies is not to eliminate fraud, but to reduce it to manageable levels, such that the total cost of both fraud and fraud prevention is minimised. This implies that high-cost low-return fraud prevention measures will not be used if their cost exceeds the potential gains from fraud reduction. This opportunity for fraud has created a black market in stolen credit card numbers, which must generally be used quickly before the cards are reported stolen.
Three improvements to card security are being introduced to the more common credit card networks at the time of writing. An additional 3–4 digit code is now present on the back of most cards, for use in "card not present" transactions. The on-line verification system used by merchants is being enhanced to require a 4 digit Personal Identification Number (PIN) known only to the card holder, and the cards themselves are being replaced with similar-looking tamper-resistant smart cards which are intended to make forgery more difficult. The majority of smartcard (IC card) based credit cards comply with the EMV (Europay Visa MasterCard) standard.
The 3–4 digit numbers for use in "card not present" transactions are to be found in different places on the various cards, and are referred to differently by the card issuers:
- AMERICAN EXPRESS: 4 digits long, printed on the front side of the card above the number, referred to as the CID, or Card Identification Number.
- MASTERCARD: last 3 digits of the number printed on the back signature panel of the card, referred to as the CVC, or Card Validation Code.
- VISA: last 3 digits of the number printed on the back signature panel of the card, referred to as the CVV, or Card Validation Value.
Credit cards as we know them today (particularly in the U.S.) began in the 1950s. In 1950, Diner's Club came into being and was the first credit card; it was followed shortly thereafter by American Express. Bank of America created the BankAmericard in 1958, a product which eventually evolved into the Visa system. MasterCard came to be in 1966 when a group of credit-issuing banks established MasterCharge.
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 instituations), including organization-branded credit cards, corporate-user credit cards, store cards and so on.
There is some controversy about credit card usage in recent years. Credit card debt has soared in recent years, particularly among young people. The major credit card companies have been accused of targeting a younger audience, in particular college students, many of whom are already in debt with college tuition and loans. Credit card usage has tripled since 2001 amongst teen-agers as well.
Since the late 1990s, lawmakers, college officials, consumer advocacy groups, and higher education practitioners, have become increasingly concerned about the rising use of credit cards among college students. A recent study has shown that both the number of students owning a credit card as well as the amount of credit card debt held by students has risen in the last couple of years. Since eighteen year-olds in most states are eligible for a card without parental consent or employment, many have been concerned that students will use credit unwisely because of their financial inexperience and suffer the long-term consequences of carrying high debt.
Some Credit Card Companies, including Providian and Capital One, are well known for pursuing legal judgments against borrowers, garnishing wages and forcing sales of homes, adding in the cost of legal fees, often exceeding the original balance several times. This practice has encouraged numerous class action lawsuits seeking redress for borrower's rights.
An example of a Credit card class action was where issuers were "rolling back" posting times to extract more late fees. The following banks are listed (with the amounts penalized).
- Providian: $405m
- Citibank: $15.5m
- Chase: $22.2m
- Bank One: $40m
Another controversial area is called, "universal default". When you are late paying one credit card issuer and your rate escalates, universal default allows other banks that you have accounts at also increase your interest rate. In short, your rate could go up to the "default rate" (much higher than a normal rate and far higher that a "teaser" rate) even though you don't default with THAT bank. Congress has been slow to introduce credit card reform legislation.
Credit card numbering
The numbers found on credit cards have a certain amount of internal structure, and share a common numbering scheme.
The card number's prefix is the sequence of digits at the beginning of the number that determine the credit card network to which the number belongs. The card number's length is its number of digits.
The prefixes and lengths for the most common card types are:
In addition, the first 6 digits of the credit card number are known as the Bank Identification Number (BIN). These identify the institution that issued the card to the card holder.
Some credit card issuers choose to restrict the card numbers they issue to those which pass a checksum test, where the final digit of the card number is used to confirm the initial digits. This has two benefits of preventing casual attempts to invent credit numbers (only one in ten will be valid), and also prevent mistakes when the card number is manually recorded. The checksum test for credit card numbers is the Luhn formula, described in Annex B to ISO/IEC 7812, Part 1.
Credit card organizations
Collectible credit cards
A growing field of numismatics, or more specifically Exonumia, 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, then metal and fibre, then paper and are now mostly plastic.