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Do you have credit cards? Do you use them all the time? Most people would answer "Yes". You probably have a couple of them in your wallet as well. How does credit card business work? You have heard that terrible things can happen if you have too many credit cards, but can you use them to your advantage?
These are some of the issues we plan to discuss in this article.
First of all, as many of you already know, credit card is an electronic payment mode. It is easy to use and just one look at your statement is enough to reconcile all the purchases you made. Credit card business is highly competitive and you would not believe some of the offers credit cards companies make to keep their customers or acquire new customers.
There are four most popular and common type of credit cards out there. VISA, MASTERCARD, DISCOVER and AMERICAN EXPRESS. These names are nothing but trademarks that a particular company uses to offer it's product.
It's easy to understand if we look at an example of a fast food restaurant. Let's look at Subway. If you know a little bit of franchise business, you know that Subway is a trade name that all independent franchise owners use. They pay fees or royalties to use this name. They also have to work with certain vendors approved by subway for their supplies. In the end, customers come to them because they know the brand and product.
This analogy works in credit card business as well. Visa international will allow banks and financial institutions to sell VISA brand credit card to their customers for a certain fee. Then there are companies who contract with VISA to process transaction and approval. These companies also pay fees to VISA International as well. So when you go to your local grocery store and use your card for a purchase, the moment you swipe the card, your local grocery store connects electronically to an authorizing companies that will approve the transaction.
Once this transaction is approved, this company will owe money to your local grocery store and all the sales are reconciled periodically between them. All these transactions are then fed back to your bank or card issuing institution that generates and mail you a monthly statement.
So on surface, credit card business model looks very simple. However, it is far from simple when you get down to details. Now, have you ever wonder, what will happen if you travel 9000 miles to a remote country and try to use your credit card? Would it work? How do they know that this card is valid? Do they connect all the way back to your bank to verify?
Answers to these questions come from a very simple concept called "redundancy for ease of use". Credit card authorizing companies maintains a database of all the credit cards issued. This information is updated on a daily basis. Trick is where and how they store this information. A company might maintain 100 Computer servers(to store credit card info) around the world. All these servers sync up periodically. So It doesn't matter where you live. You might live in United States but your credit card information is also stored on a server sitting somewhere else, for example Australia. Idea is to offer a faster and more reliable approval and transaction processing system in case you travel to Australia. All these servers store duplicate information but in the end, it helps to speed things up.
Now what is the difference among various credit cards, for example cash back, rewards etc? If you look closely, these are just marketing techniques to get a customer. For example, if you travel a lot, you might be tempted to try a credit card that offers Airline miles for purchases.
Some credit cards offer a cash back(usually 1% of the purchase). It seems like a oxymoron concept that you will use a credit card to earn money. Didn't you get this card to spend money to start with? Well, you did, but if you own a business and spend lot of money to buy inventories or products, it isn't a bad idea to get some money back, even if it is just 1%.
Same goes for credit cards that offer airline miles for your purchases. if you travel, why not save some money on tickets by using them.
Now how could a credit card be a good thing? Trust me, if you're financially responsible, a credit card could do amazing things for you. credit cards companies bet that a customer isn't going to pay in full every month. And that's true 95% of time and that's what make them money(double digits interest rates).
However, if you use your card responsibly and pay the balance off every month, you can use some of the offers they throw at you. Most of these offers are intended to get you in trouble, but if you understand them well, you could save thousands of dollars in interest payments.
Here is an example. Most credit cards companies will offer you 0% rate for a year with no balance transfer fee or sometimes 3.99% for the life of the balance.
Now let's think about it and see what can you get out of it. You could take out a $20,000 credit for $3.99% and buy a car you were looking for. Even if your credit scores are stellar, your interest rate on a car loan isn't going to be cheaper than 5-6%. So there is the saving. Also remember, if you get $10,000 for a year with no interest, you could deposit it in a CD earning 5% and make $500. Even if you have a balance transfer fee(3% of $90 whichever is higher), you would still make $410. One couple in NY took out $50,000 balance on a credit card and put it in a CD earning 4% and made $1800 at the end of the year. Great rewards for being financially responsible.
While these are great ideas and you could make money using a credit card. Bottom line is not allowing it to go over your head. Remember most people get deeper and deeper in credit card debt because even though they understand the consequences, they don't see them up front. So don't do what your credit card company expect you to do. Be an exception and you could make money with pretty much anything.
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