How credit cards work

Sep 13, 2020

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Editor’s note: This post has been updated with the latest information.

You’ve probably already used one of your credit cards today. After you finish reading this article, there is a decent chance that you’ll use it again.

And despite the ongoing COVID-19 pandemic and record unemployment, the average amount of individual debt has consistently declined since the onset of the pandemic. Average credit scores are increasing at a higher rate than during this same period last year, and credit utilization — how much available revolving credit a consumer is using — is at a record low for the past five months, according to Experian data from July 2020.

Credit cards still offer a convenient, simple and rewarding alternative to handing over dollar bills, but there is a lot happening from the time you swipe your card to the time a transaction is approved. If you’ve ever wondered about the information flow while waiting to see the “approved” message, here’s a look behind the scenes.

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In This Post

Authorizing your purchase

When you insert your card or input your number online, it initiates a volley of information between a number of parties. “There’s a lot of stuff that you can’t see,” said Mark Nelsen, senior vice president of risk products and business intelligence at Visa. “Behind the scenes, there is so much happening. Whether you’re using contactless payments or inserting a chip card, there is a whole suite of cryptography happening to tell the merchant that the card is authentic.”

In addition to making sure that the card is authentic, it’s also making sure that you have enough available credit to cover the charge. The first stop on the journey relies on a payment processor. For example, PayPal is a processor. The processor passes your information to the network of the card issuer such as Visa, Discover, MasterCard or American Express.

The issuer sends the information to the bank that gave you the card. At that point, your personal finances play a role in determining whether the purchase is approved. If your card is maxed out, your card is declined. This is also where the bank’s algorithm might flag suspicious activity that indicates the card may be stolen. If all seems well, the bank gives the go-ahead for the transaction. The approval or denial message travels on the same return path, passing through the card issuer’s network, the processor, and finally, back to the merchant who lets you leave the store with your goods or sends you a confirmation email that your products are on the way to your door.

Related: 7 reasons why your credit card may have been declined

Photo by @Lesia.Valentain/Twenty20
(Photo by @Lesia.Valentain/Twenty20)

Powering faster processing times

When you recognize all the back-and-forth communication that must occur, credit card processing seems very quick. However, we live in the age of instant gratification, and every second of delay can frustrate some shoppers.

To speed things up even more, Visa has its Quick Chip for EMV technology, while MasterCard uses M/Chip Fast. Both are designed to make credit card transactions even faster. For in-person transactions, Nelsen predicts that we’ll see those times continue to decrease. “The processing time is largely based on the logic in the payment terminal, which is determined by what the merchant wants to do with the data,” Nelsen said. “Merchants will continue to optimize that software logic to make it as fast as they can.”

Making the final settlement

No matter how quickly you receive approval, though, there is still work left to do. The funds still need to make their way to the merchant. That’s why your online credit card account has “Pending” next to your most recent transactions. In addition to transmitting the money, the amount may change. For example, a restaurant bill is approved for the base price without the tip. The restaurant has to add that gratuity into the final amount.

The settlement process operates in a similar manner to the initial authorization. The merchant sends the processor its transaction information, which is passed along to the issuer and the bank, and the funds make their way into the merchant’s bank account. Now, you officially owe your bank for the purchase. But hopefully, they owe you some meaningful reward points, too.

Featured photo by Getty Images

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Editorial Disclaimer: Opinions expressed here are the author’s alone, not those of any bank, credit card issuer, airlines or hotel chain, and have not been reviewed, approved or otherwise endorsed by any of these entities.

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