Since debit cards and credit cards generally have the same format, we will introduce them together and use credit cards as the main example. Credit cards and debit cards are also called bank cards. When we apply for a credit card, we often apply to banks, such as Citi, Chase, and TD Bank. The bank will issue us a credit card based on our credit history. On the card there’s often a logo from the issuing bank. However, there are also different logos, such as Amex, Visa, or MasterCard. These are the names of credit-card networks.
When you go to a store or a restaurant, the staff will tell you what kind of credit card they accept based on the card network, not the issuing bank. The reason is that the issuing banks don’t deal with the merchants directly. They have to go through the card network. The network acts as a bridge between the merchant’s bank and the customer’s bank to help them exchange information and the money associated with the transaction.
Although there are thousands of banks in the United States and even more in the rest of the world, there are only a handful of card networks. The four major networks in the United States are MasterCard, Visa, American Express, and Discover. Outside the United States, there are two more major credit-card networks: one is China Union Pay (CUP) and the other is Japan Credit Bureau (JCB). Their logos are shown in Figure 5.
There are four main credit-card network companies in the United States—MasterCard, Visa, American Express, and Discover. JCB is a Japanese credit-card network, and China Union Pay is a Chinese credit-card network. A typical credit card has issuing-bank and card information on the front and signature and bank information on the back.
How do debit cards and credit cards work? Debit cards and credit cards are quite similar in many ways. They both
- have a similar format as a plastic card with an embedded chip or a magnetic stripe;
- carry the symbol of a major bank or credit-card company logo;
- have a card number, your name, and an expiration date;
- can be used anywhere that credit cards are accepted;
- make it easy to track where and when you made purchases and how much you paid; and
- are convenient to use and easy to take with you.
However, they are fundamentally different in the sources from which the cards pull money.
A debit card takes money from your bank account directly. If you don’t have enough money in your bank account, you will not be able to make the purchase. Imagine there is a store that accepts only cash, and you have only a debit card in hand. Fortunately, there is an ATM at the street corner. You can take cash out from your bank account using the ATM and then make a purchase from the store with the cash. If the store accepts your debit card, it will save you a trip. It also helps you combine the two steps into one, except that
- the ATM at the street corner is now the card reader on-site;
- you take out the exact amount of the money you need to pay, instead of $20 bills; and
- you don’t need to touch the cash yourself.
When you swipe a debit card, the card reader will read the information stored in the magnetic stripe. If what you have is a debit card that is equipped with an EMV chip, you can insert it into the reader. The card reader will “talk” to the chip and read the card information stored in the chip. To prevent fraud, many cards require a four-to-six-digit pin.
Your account information, together with the request for a payment, will be sent to the processing center of the corresponding card network. The card network will first contact your bank. Your bank will check whether you have enough in your deposited funds to cover the payment and then pass the information to the card network. With your confirmation, the card network will transfer the requested payment from your bank to the merchant’s bank. If you don’t have enough money in your linked bank account, it will decline the payment. You must either abandon the purchase or try to find another way to pay for it.
On the other hand, when you use a credit card, you are taking a temporary loan from the credit-card company. You don’t have deposited funds at your credit-card company, also called the issuing bank. At the front end, the usage of a credit card and a debit card is exactly the same. The difference is at the back end. When the card network contacts your credit-card bank, your bank will conduct a quick analysis based on your credit history, account history, the purchasing price, and a lot of other information about you. With help from many sophisticated mathematical models and advanced computer power, its computers can make the decision in a fraction of a second.
- If the answer is yes, the bank will lend you the money equal to the requested payment. Then the card network will coordinate the transfer of funds from your bank to the merchant’s bank account to pay for this transaction. Note that the money is not yours. The bank is paying it for you, with the expectation that you will pay it back soon.
- If, unfortunately, the answer is no, then your card is declined. This means that your bank doesn’t want to lend you anymore at that time. You either abandon the purchase or try another method of payment. A common reason for being declined is the credit limit on your card. That is the maximum amount your credit-card company is willing to lend you. If your accumulated loan (purchase + interest + fee) from the card account has reached the credit limit, the bank will stop any payment attempted with the card. When you pay the bank enough money, your total loan will be reduced. Then you can make purchases with the card again.
Every month, you will get a statement from the credit-card company. The statement tells you that you owe a certain amount of money. It generally comes with a detailed description of where and when you made payments with the credit card the previous month. You will also will be assigned a due date as the date on which the company requests the payment. Generally, the credit-card company will give you a grace period (usually a month), so you are free from interest charges, provided that you pay the entire bill before the due date. However, if you can’t pay the entire bill, you will be charged interest; sometimes it can be as high as 19.99 percent or even 29.99 percent per year. If you miss the due date and pay the bill late, you will also be charged a late fee ranging from $15 to $50.
A credit card is generally considered “easy access” credit. As long as you are approved for a credit limit, you can start to borrow money any time you need to make a purchase within the limit—no questions asked. However, since you are borrowing money for your spending, it is very easy to overspend, which means spending beyond what you can afford. If you can’t pay the bill when the credit-card statement comes, you will be charged interest. In some cases, the interest accumulated can be even higher than the purchase you made.