How do Credit Cards Work?

It was already mentioned that credit is important in Canada. It is important for getting cell phones, purchasing larger appliances, cars and, maybe one day, homes. One good way to start building credit is by getting credit cards. They can eventually lead to a car loan, which then seriously shows some re-payment power, capital worthiness and takes you up the credit ladder. Often even employers reach in our credit history and draw conclusions based on information posted there. Good credit is hard to build and really easy to damage. Everyone who has your name, address and birth date could potentially get access to your financials. In Canada, due to the small amount of population, they do not even need your social insurance number. This personal information is to be safeguarded at all cost.

In credit cards and electronic transactions, there are typically two sets of stakeholders:

-buyers or consumers

-merchants or business owners

On the other side of the equation:

-banks/credit card companies

-Visa, Master Card and American Express. In the US they also have Discover. Here and there one can see Diners Club which is rare.

When a person buys a product from a store via a credit card terminal, quite a few transactions happen. For any business to accept credit cards, they have to get a merchant account – it connects them to the credit and debit card processors. Yes, these businesses actually have a cost for every transaction made on credit/debit card.

Once a card is swiped, the seller’s merchant account reaches out to Visa, for example. Visa then contacts the bank of the card issuer and makes sure that there are funds available. Based on money availability the credit card terminal issues an approval or an rejection code.

Fee structures of credit cards

In the US most of the credit cards are free. The ones that have annual fee typically offer some exceptional service levels such as personal concierge and other services which in Canada are ultra expensive. Here, most of the credit cards charge an annual fee which is sad. When a merchant swipes a card, they pay a certain flat amount or a transaction percentage to Visa or American Express or whoever the card is with. Visa then turns around and pays a small fee to the bank which issues the card. Visa makes money from the business owners, the banks make money from Visa. The more people use credit cards, the richer Visa and the banks get. Plus the banks charge annual fees…

This is the reason why banks can afford to partner up with various insurance, travel, gas station, gift, cashback etc. programs and offer incentives for usage. The more people use the cards, the more points they get. Consumers pay their annual fee, the merchants pay per transaction and make the banks wealthy.

Most debit cards use the Interac system which is also a for-fee service for companies yet a smaller amount than Master Card or Visa. American Express tend to have the highest fees which is why vendors often avoid them. American Express also seem to have the best service and plans with some free cards and many perks for the consumers. From the perspective of an end user, American Express is probably the sweetest card.

One comment

  • admin
    November 18, 2011 - 9:36 pm | Permalink

    One other thing to watch out for is going over the credit limit in credit cards or dropping below zero for debit and other bank cards.
    Many cards offer overdraft protection. They will cover the amount if is up to a certain amount and you do not have to worry about it. Often there are hefty fees for as much as $40 to cover the two or three dollars you went under.
    Banks do that on purpose – they will allow you to drop below zero and then charge you a nice over-credit-limit fee or below-zero. Plus there maybe different interest rates applicable to “rogue” (as in below zero) balances and you may not see it for a few weeks. Automatic scheduled payments can be quite surprising sometimes.