Gears of a Machine: How the Credit Card Industry Works

For some people, the idea of credit can seem a little bizarre. Particularly people who grew up used to paying for everything with cash or sometimes with a check. There were very few middlemen in purchases like that. When you buy something with cash, both you and the merchant have the commodity they are seeking right away. There's nobody in the middle charging you fees or holding payments for three-to-five business days. The world doesn't work that way anymore. Yes, you can still buy things with cash. It's still the safest way for merchants to make money, and the most trusted form of money available for day-to-day purchases. But now you have huge credit companies in the picture as well who are somehow making money off of your spending. It can seem a bit confusing when you're just beginning to learn about it, but at its core it's a pretty simple system. Here are the basics of the credit card industry:

What Makes The Credit Industry Go 'Round

When you use a credit card to buy something, it's like having someone else pay for your purchases. In a sense, you haven't really spent any of your money on anything yet. The credit card company has spent its money to buy you whatever it is that was purchased. The credit card company keeps track of this. Anything they buy for you during the month is listed with details of when, where and how much it cost, and tallied up at the end of the month. This is your bill. When your bill comes at the end of the month, that's when it's your turn to spend your money. You have to pay the credit card company at least a part of the money they have spent buying things for you. Typically there is a minimum monthly payment that is either a percentage of what you spend per month, or a fixed dollar amount. You pay the credit card company this amount or more, and they recoup some of their money. Let's say that you pay the minimum amount, and let's say that it's $10 out of the $100 spent by the company. After you pay that amount, the credit card company has spent $90 more on you than you have given back. They take what's leftover after you pay your bill and apply an interest rate to it. They multiply the amount of money left after you've paid your bill ($90) by a number that you have both agreed upon. Let's imagine this number (the interest rate) is 10%. The new total after the application of the interest rate is $99, and that becomes the new total amount that you owe them. This is how they make money. Those amounts of interest are used to pay the business bills and pay their employees. The business owners also use that as their income.

Credit Reporting

The records of all of your paid bills along with any late payments, underpayments, full payments or other details about how the payment occurred are recorded and reported to the three major credit reporting bureaus. These agencies keep track of all of your payments and assign you a credit score that serves as a general overview of your credit behavior. Other credit card companies, banks, car dealerships and loan officers use this number to determine how much of a credit risk you are and thus, whether they want to give you more credit. There are many other facets to the complex credit industry, but those are the basic movements within it. For more complete information, consult the web pages of individual credit card companies or credit reporting bureaus. There are also plenty of good informational websites that go into deeper detail about the way the industry works.