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Understanding Credit Cards

Updated on September 07, 2009

A credit card is a means of identification by which the owner may obtain consumer credit for the purchase of goods or services rather than pay cash. At the time of sale he presents his card to the seller, who records the purchaser's name and account number along with the price of the purchase. Records are sent to a central billing office that calculates the total price of purchases made by the card owner during the business month and sends him a bill. The purchaser returns his personal check, covering all or part of the total, to the central office, which allocates the money to the establishments entitled to it.

The credit card, an American innovation, first gained national popularity in 1938 when oil companies selling gasoline to consumers set up a national pool to honor each other's cards. Rapid growth, however, was not possible until the mid-50's, when the development of electronic computers permitted fast, accurate billing and accounting. Department stores, airlines, banks, hotels, and other enterprises then entered the field and now offer credit to over 140 million card owners.

Charges and Interest

Service charges or interest rates levied against card owners vary with the types of retail establishments involved. For businesses where individual purchases are small (for example, among oil companies selling gasoline to consumers) and total charges are generally paid within one month, card owners usually pay no service charges, and no interest is charged on unpaid balances until after six months.

For department stores, individual purchases are often very large, and installment payments are common. Such stores need their funds for investment in inventories and cannot afford to allow card users to incur a large interest-free debt. Accordingly, their credit generally carries an interest charge on all purchases that are not paid for within one month. The rate is high, commonly 18% per year.

In another type of credit system, the credit card is issued by banks or credit companies and can be used at a large number of licensed agencies, including hotels, retail establishments, and restaurants. Because the agency issuing the card has no direct role in the retail sale, it must take its profit by charging either the card owner or the retail establishment. Both techniques are employed: some agencies levy an annual service charge against the owner as well as charging interest on unpaid balances; others charge the retail establishments a percentage of their total billing.

Advantages and Disadvantages

Credit cards offer advantages to both parties in a sale. With only one monthly billing, credit card owners are better able to synchronize their receipts and expenditures. Companies that are too small to undertake the expense and risk of instituting their own credit system can affiliate with a national card system and offer credit.

One disadvantage of the system is that the extension of this type of credit is beyond the control of the Federal Reserve System. Another disadvantage is that the informality of the use of credit cards makes theft and fraud quite simple. Card owners are generally liable for all claims submitted on lost or stolen cards until the central office is notified of the loss.

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    • GeneralHowitzer profile image

      Gener Geminiano 7 years ago from Land of Salt, Philippines

      I think it is better to use cash than to rely on this plastic trap... overall its a great hub... thanks for sharing...

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