How credit card Works ?

Discussion in 'Money Matters' started by madhurisatya, Jun 2, 2009.

  1. madhurisatya

    madhurisatya Silver IL'ite

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    You have a lifetime free credit card.
    You have spent Rs. X on shopping. You get the bill after 30 days and
    the payment due date is 20 days later.
    You pay back the same amount (Rs. X) before payment due date.
    You have used banks money for 50 days without paying any interest.
    So what does the bank gain here? Have you ever wondered?
    Read on, its interesting. ...

    Ramya: I want to buy a Sony digital camera costing Rs.20,000, but I
    don't have any cash right now.

    Raj: Why don't you use your ICICI Bank credit card? Never heard them say
    ? Hum Hain Na ??

    Ramya: I am quite skeptic about using these cards. I pay using the card,
    get a bill after 30 days and pay after another 20 days. This is a
    maximum of 50 days interest free loan. Why does any bank do it?

    If I borrow Rs.20,000 on personal loan at 11%.
    Interest to be paid for 50 days = Rs. 20,000 * 11% * (50/365) = Rs.
    301.40 .

    Here the bank is giving me a loan without interest when I use the credit
    card. Something is wrong somewhere!

    Raj: Well? let me tell you how it works when you use your card to pay
    for the camera.

    * You present your ICICI Bank credit card ? a VISA card.
    * Sony World swipes your card on a machine provided by Citibank.
    Lets call Citibank ? the acquirer bank and the process of Sony World
    swiping the card on that machine ? requesting authorization .
    * Citibank communicates with the card issuer ? ICICI Bank through
    VISA Network to check if the card is valid and has the required credit
    limit.
    * ICICI Bank reviews and approves / declines which is communicated
    back to Sony World.
    * You sign a receipt called Sales Draft given by Citibank. This is
    the obligation on your part to pay the money to ICICI Bank. Data on this
    receipt can be captured electronically and transmitted.

    At the end of day or at the end of some period Sony World chooses:

    * Sony World submits the receipt you signed to Citibank who pays
    Sony World the money. Sony World pays Citibank a fee called Merchant
    Discount . Let us say this is 6% of the sale value = 6% * 20,000 = Rs.
    1200
    * Citibank sends the receipt electronically to a Visa data center
    which in turn sends it to ICICI Bank.
    * ICICI Bank transfers the money to a settlement bank which in
    turn transfers the funds to Citibank.
    * Citibank pays ICICI Bank an Interchange Fee of 4% of the sale
    value = 4% * 20,000 = Rs. 800
    * 20 to 50 days later ICICI Bank gets the money from you ? and you
    don?t pay the interest!!

    Ramya: Interesting! So Sony World pays more than the interest that I
    should have paid for the loan that I take. I, as a cardholder have the
    following benefits

    1. Convenience of not having to carry cash.
    2. Credit availability ? free of interest.


    However what benefits does Sony World get for paying so much money?
    Isn?t it more profitable for them to take cash? They can save as much as
    Rs.1200.

    Raj: Certainly. Some retail outlets offer you discounts if you pay by
    cash, don?t they?

    However when you don?t count the money that you are spending, you tend
    to buy more! Cards encourage this ? called impulse purchase .

    If you did not have access to credit, you would not have bought the
    camera this month ? or may be not any time soon either. By accepting
    cards, the merchant is actually extending you credit at the risk of the
    card issuer. He pays money to the banks to carry that risk.

    Ramya: So ICICI Bank uses this money to pay back to us when they
    announce 5% cash back. They insist that the Sales draft that I sign at
    the retailer should also be from ICICI Bank. This means they are saving
    on the Interchange Fee and also pay me a part of the Merchant Discount that they get.

    Raj: Exactly! If you have noticed, ICICI Bank gives you the cash back in
    the next credit card statement. They keep the ?cash back? money for a
    maximum of 60 days before passing on a part to you. This accrues them
    interest too.

    Say if ICICI Bank earns an interest of 6% per annum for the cash they
    carry ? they get Rs.1000 * 6% * (60/365) = Rs. 10

    That is not huge, but money nevertheless. And when you consider that
    almost everyone in this city shops with a credit card these days, it is
    a big sum.

    Ramya: And that also explains why banks tie up with petrol pumps ? like
    ICICI Bank has tied up with HPCL and I could re-fuel there without
    having to pay the fuel surcharge of 2.5%. The card issuer and the
    acquiring bank is the same and that saves interchange fees.

    Raj: Good! You seem to have figured out how it all works! Let me
    summarize:

    All the numbers used to explain concepts in this article must be treated
    only as an example. Merchant Discounts may vary from bank to bank.
    Interchange Fee is regulated by VISA and MasterCard.

    Source: email
     
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  2. nehajagadeesh

    nehajagadeesh Senior IL'ite

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    madhuri ,
    thankyou so much . i always had a doubht regarding the credit cards and their payments . but now i understood everything in detail.

    :cheers
     
  3. mrl

    mrl New IL'ite

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    Hi Madhuri,

    Its very very useful and informative article.

    Keep posting .......
     
  4. amihere

    amihere Platinum IL'ite

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    Hi MadhuriSatya
    This is an informative post, it helped me understand more about Credit card.But I have another query, I heard that if you are not possible to pay the amount by due date and if you have a Credit card of another bank then you can pay the amount to previous bank using this credit card, thus your total days to pay the bill increases to double that too without any interest.But here what will the profit for both the banks??!! Can anyone clear my doubt?
     
  5. msl01

    msl01 New IL'ite

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    OOh my god ...which means Manufacturers like Sony actually build in a "premium" in the selling price bcoz many ppl buy on credit cards..if .we used only cash transactions... the deal wud be more straight forward and...cheaper:? hmm........:bonk
     
    Last edited: Jun 24, 2009
  6. peartree

    peartree Platinum IL'ite

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    Credit Card

    Hi there

    Can anyone suggest any specific credit card to use overseas (in India) that does not charge the 3% surcharge? I heard that CapitalOne does not charge. Can anyone please help me?

    Thanks a lot!
     
  7. henrythomas

    henrythomas New IL'ite

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    Your biggest enemy

    Hi Friends.

    You’ll never earn your financial freedom if you keep on paying with your credit cards. Surely, it’s nice to have them for emergency situations, but buying a new pair of shoes isn’t an emergency, I hope we can agree on that. So, if you are already moving money from a credit card to another, trying hard to make ends meet, you’d better stop spending from the credit cards and let them slowly get balanced. Be careful with those credit cards, as they are not all alike. Some of them are more expensive than others, so make sure you repay the most expensive ones first, then get rid of the debt on the others. Then, after you’re done, either cut your cards in pieces or simply control your shopping impulses better and don’t use the cards unless you have a real emergency that needs immediate attention.
    Tanks.
     
  8. Shanthisreadymx

    Shanthisreadymx New IL'ite

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    Thank you very much. I come to know about Credit card facilities

    With regards
    Shanthi:bonk
     
  9. Sruthi

    Sruthi Bronze IL'ite

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    very clearly explained with examples good one!

    thanks for sharing the complete process

    keep rocking:thumbsup
     
  10. MeenLoch

    MeenLoch Silver IL'ite

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    If minimum amount is paid towards credit card balance where do banks charge us ?

    Suppose I borrowed $x with y% interest rate, and I pay the minimum balance every month, where am I charged the APR. Does some percentage of my monthy due go towards interest and principle. How do I find what percentage it is ?
     

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