Credit cards: how do they work, advantages and downsides

By banqo.fr

Updated on: 29 Mar 2020

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What is a payment card?

One of the most important inventions of our times may be a small plastic card of precisely 85.60 x 53.98 millimetres with rounded corners, which we can use almost anywhere in the world, or online to make payments, or to withdraw money. We generally call this the "credit card", although technically speaking, there are different types of cards. In this article we will introduce you the very credit card, its usage and its benefits, along with some nice to know things about it.

How does a credit card work?

The credit card is essentially used to manipulate money in an electronic way. Although rather an old instrument, it got acclaimed in the recent years because of its convenience and simplicity of use. The card may seem just a piece of plastic, with some attributes on it, allowing you to make payments (off and online) or withdraw money, but in order for you to have access to all this simple actions, a big machinery is set behind.

The credit card's main competitor is still the paper money, but recently electronic payments made via smartphones or smart watches got their way through. The credit card comes with several advantages: easy to carry, security of transactions, access to online payments, limited spread of bacteria, which may be largely more present on the paper/plastic money, payments world-wide without the need to get local currencies, access to sometimes exquisite benefits, and so on and so forth.

But how does actually work the credit card?

To start with, in order to get a credit card you need to open an account with a financial institution, usually a bank, which will issue the credit card for you (credit card-issuing bank). Usually the card issuer and the bank where you opened an account are the same entities, but more and more, the credit card issuer and the bank may not be the same organizations.

Once you obtained the credit card you will be able to make payments to merchants. When you make offline payments (in shops), what you actually do is to order your bank to make the payment to the merchant's bank account (acquiring bank). The transaction takes place via a Point of Sale (POS) system, a paying machine provided by a bank, or a private intermediary. It works similarly for the online payments, but in this situation, you will have to provide online some information about yourself and your card. No need to interact with the merchant. No need to go to the bank. In both cases, the transaction takes place in milliseconds.

For the transactions to be possible, the banks need to be highly integrated and in addition to be connected to a specific technology which allows the transfer of money via standard and secured protocols. The technology is run by card issuing bank associations, such as Visa or MasterCard. Besides providing the technology, the latter also set the conditions of its use by the merchants.

Finally, more and more the credit cards offer benefits to the cardholders in the form of insurances or access to exquisite advantages (i.e. car rental insurance, travel cancelation insurance, purchase security, etc.). They are run either by insurance providers or partners that try to promote their services.

What kind of credit cards can you have access to?

Once you got the card, you can proceed to all sort of operations and get access to benefits. However, you will have access to a limited number of benefits, as they depend on the card you chose.

For instance, the main feature of the credit cards, compared to the other payment cards (i.e. debit cards, prepaid cards, etc.), is that essentially they will give you access to a credit. The credit is offered either by the card-issuing bank, beyond the deposit you made with the back, or by a third party entity, based on the repayments arrangements you made with that entity.

The debit cards and the prepaid cards will only allow you to make payments within the limit of the available amount of money in your accounts. This is to say, you play safe and you consume only the resources available in your accounts (i.e. no credit). Sometimes these cards can offer access to benefits, but to a limited extent.

You have access to a credit card. But how does the whole system work?

Although it differs from a card-issuer to another, in general, the access to a credit card will cost money. The way you will pay for the credit card will depend on the type of the card, the benefits you can have access to, and on the usage of your card.

First and foremost the initial cost may take the form of a subscription fee, paid in monthly or annual instalments to the card-issuer bank. In addition, you may also be charged for the interest you amass on the outstanding balance. For instance, the balance of the credit to which you have access to via the credit card, needs to be paid either in full each month (or at least a minimum amount), or you can build continuing balance of debt, subject to interest being charged. The interest is to be paid either on the transaction, or on the outstanding balance.

The merchants also need to pay in order to be able to trade via this payment system. The arrangements are very complex contracts, but typically it is assumed that the fees are either something between 1 and 6 percent per transaction, or a lump sum, if the transaction is too small. The fees will vary not only from merchant to merchant, but also from card to card. The merchants will include these fees in the price of the goods or services they sell. Since it is rare to have the same product with a price for a cash transaction, and another price for a card transaction (which will include the fees), this means that ultimately the price of the cash transaction is slightly inflated and that the cost of using the card is supported by the cash payers.

How secure are the transactions made with the credit cards?

From a general perspective, the transactions via payment cards take place in fractions of seconds. This rapidity hedges against potential frauds.

But how the security measures do work for credit cards?

First and foremost, the cards are identified by the name of the user, by the number of the card, which corresponds to a bank account, and the expiry date of the card. On top, a magnetic strip or a chip will embed these identifiers and will allow the communication with the issuing bank or merchant's bank throughout the transaction.

In online transactions, all these elements, along with additional security codes generated via mobile phones, allow for a high level of security of the transactions. In offline transactions, besides certain amounts, most of credit cards require the use of the PIN as the signature for the transaction.

In case of theft of loss of the credit card, the card holder has the possibility to notify the event via mobile apps or to a bank clerk via phone, who, after the identification of the user, can block the card and any potential pending fraudulent transaction.

The banks invest important amounts of resources to avoid fraudulent transactions. For example, each transaction passes through a clearing process and when potential security breaches are spotted (i.e. payments made over usual thresholds), concrete actions may be undertaken: the transaction can be blocked or it can be checked by the bank clerk in real time with the cardholder.

Despite all the efforts made by the banks, the security of your credit card starts with you. Hereafter we offer you several suggestions to keep safe the use of your credit card:

  • Keep your PIN code away from indiscrete eyes
  • Do not communicate it to anyone, banks will never ask for your PIN number in an email, online form or over the phone.
  • When withdrawing money from ATMs:
    • prevent anyone to observe the card details and / or your PIN
    • make sure that there is no unusual device in the machine able to record your card details
  • When paying offline (in shops) prevent anyone to observe your PIN
  • When paying online:
    • pay only on trustful sites
    • avoid payments on sites that do not have the security protocol "https"

The card is of personal use, so don't make it a public good!

What are the advantages of credit cards?

First and foremost, the two biggest advantages of the credit card are convenience and simplicity. Provided your credit arrangements allow, you can travel the word and not worry about currency exchange, access to cash, or payments with merchants. You can pay with the credit card in millions of merchants POS, as well as you can withdraw money from millions of ATMs all over the world. You just need to spot the merchants that allow the payment with credit cards. However, know that the transaction may be subject to exchange rate fees, so you better check these fees prior to your trip, especially in countries outside Europe

The second advantage of the credit card is that it gives you access to small short-term loans. Since the credit card comes with interest, you need to make a wise calculation, for the accumulated interest not to exceed the maximum credit line for your card.

The third advantage of the credit cards is that it gives access to all sort of benefits: i.e. access to insurance of the goods acquired, enhanced product warranties at no cost, travel insurance, car rental advantages, travel medical insurance etc. Last but not least the credit cards give access to loyalty programs, where for each purchase you may be rewarded with points, which may be redeemed for cash or products, or you can receive a discount directly on your card in form of cash-back.

Are there any downsides of the credit cards?

When people pay with credit cards and with cards in general, they tend to value differently the money and spend more than if they would have paid in cash. This, along with the tendency for consumerism, may lead some people to high level of indebtedness and potentially to bankruptcy. So rather be wise in your consumption behaviour!

More generally, the slightly inflated prices for the non-card payments do support the very credit cards system and the benefits for the cardholders, which recently was spotted as an issue that may have an impact on the social welfare and its distribution. For instance, it is believed that credit card rewards would result in an annual transfer of more 1.000€ from the average cash payer to the average card payer.

Although generous on paper, the access to the benefits may not be that easy to get in practice. Benefits are often hidden in the card-issuer website, or in order to unlock them, frequently one needs to call special phone numbers (with high costs), which requires resilience and commitment. So the cardholder may end up with the perception of ownership over the benefits, but with a real limited usage of them, in practice.


Beyond any doubt, the very existence of the card has eased and will continue to ease the cardholder life, as she will be able to pay at merchants all across the globe, pay online, or withdraw money at ATM terminals. However, make a wise use of the card in order to avoid potential risks!

5 things you probably did not know about credit cards

  • The payments with credit or debit cards represent as much as 60% of the total transactions between 10$ and 100$.
  • The very first time the cards were described was back in 1887 by Edward Bellamy in his utopian novel Looking Backward
  • United Kingdom is one of the world's most credit card-intensive countries, with 2.4 credit cards per consumer
  • Using the credit card one may prevent the contact with paper/plastic money and prevent bacterial infection
  • Wireless payments at terminal make the contact even less infectious.

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