How to Use a Credit Card
Paying by credit card sure is convenient.
Just hand the card to a merchant, sign the receipt, and walk away with your newly purchased item. A couple of days later, the charge shows up on your credit card bill and you pay the bill when it’s due.
And that’s that. Or is it?
There are a whole lot of fast and furious electronic dealings happening behind the scenes of every single credit card transaction. This article gives you a closer look at what happens from the time you hand your credit card to a store clerk and the new charge that turns up on your card bill.
Let’s say you’re buying an $800 sofa from Joe’s Furniture. And you’re paying for the sofa with a Visa credit card issued by XYZ Bank.
The first step is getting the purchase approved from your card issuer, XYZ Bank. The sofa that you love won’t budge until your bank authorizes the purchase.
The store clerk swipes your credit card through an electronic approval machine, enters the dollar amount of the charge, and an electronic authorization request is sent out.
But this authorization request doesn’t go straight to your bank. It has a couple of stops to make first.
The first stop is the bank that handles credit card transactions for Joe’s Furniture. We’ll call this bank Joe’s Bank.
Joe’s Bank receives the authorization request from Joe’s Furniture and sends the request to Visa.
Visa is an association made up of banks that issue Visa cards to consumers and banks that sign up merchants to accept Visa cards for goods and services. Visa also operates a huge consumer payment system that handles credit card transactions between its member banks. (MasterCard offers a similar payment service for its member banks and financial institutions.)
To recap, the friendly clerk in Joe’s Furniture swipes your Visa card through an electronic approval machine and punches in the dollar amount of the sofa you’d like to buy. An authorization request gets sent to Joe’s Bank. Joe’s Bank sends the request to Visa. And Visa passes the authorization request on to your card issuer, XYZ Bank.
Now, XYZ Bank has the choice of declining or approving the request. XYZ Bank will approve the purchase as long as there’s plenty of room in your credit line for an $800 charge.
We’ll assume that XYZ Bank approves the purchase. XYZ Bank sends back an electronic approval to Visa. Visa forwards the approval to Joe’s Bank, and Joe’s Bank in turn sends the approval to Joe’s Furniture. The clerk at Joe’s Furniture receives the electronic authorization and prints a sales slip for you to sign.
When you sign the receipt, you’re agreeing to pay the $800 charge for a sofa from Joe’s Furniture. You tuck your copy of the sales receipt and your credit card back into your wallet. And you take your new sofa home.
Joe’s Furniture has to pay for this convenience. Retailers that allow customers to pay with credit cards have to pay a “merchant” or “interchange” fee to the credit card processor. This fee is usually about 2% of the transaction, plus other monthly fees. In this case, Joe’s Furniture has to pay $16 for your sofa purchase.
While you’re home re-arranging furniture, the $800 charge makes its way toward your credit card account.
The merchant copy of the $800 sales receipt is deposited into Joe’s Bank that evening. Joe’s Bank credits the account for Joe’s Furniture and submits an electronic transaction to Visa.
Visa pays Joe’s Bank, debits the account for XYZ Bank and passes the electronic transaction on to XYZ Bank.
XYZ Bank posts the $800 charge to Joe’s Furniture to your credit card account. This charge will appear when you check your account online or receive your monthly statement. Depending on your credit card terms, you have a set amount of time to pay off the $800 balance before it starts to be charged interest.
The whole process starts all over again each time you make a purchase with a credit card.
A merchant isn’t able to swipe your actual credit card when you pay by phone or online. Instead, the merchant asks you for the name on the card, the account number, the expiration date, the billing address for the account, and often the security code on the back of the card as well.
Let’s say you’re using a credit card from ABC Bank to order a $50 bouquet from an online floral shop called Sue’s Flowers.
You place an order for a $50 bouquet and type in your credit card account information and billing information on the website for Sue’s Flowers.
Sue’s Flowers uses your credit card information to send an authorization request to its bank, which we’ll call Sue’s Bank. Sue’s Bank sends the authorization request to Visa.
Visa passes the authorization request on to ABC Bank, the bank that issues your credit card. ABC Bank approves the charge and sends an electronic approval back to Visa.
Visa forwards the approval to Sue’s Bank and Sue’s Bank sends the electronic approval to Sue’s Flowers.
And voila… your $50 bouquet purchase has been approved.
The payment process begins once Sue’s Flowers deposits a receipt for the online transaction to its bank. Sue’s Bank credits the account for Sue’s Flowers and sends an electronic transaction to Visa.
Visa credits the account of Sue’s Bank, debits ABC Bank account, and sends the electronic transaction to ABC Bank.
ABC Bank posts the $50 charge from Sue’s Flowers to your credit card account. This charge is listed on your next monthly credit card statement.
Amazingly, all of these requests and receipts between merchants, banks, and credit card issuers take only a few seconds to complete. Next time you use your credit card, you’ll know exactly where your information goes and the process involved in getting it there.
A high credit score often equals savings on loans and credit cards.
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