How Credit Cards Work

Have you ever stood behind someone in line at the store and watched him shuffle through a stack of what must be at least 10 credit cards? Consumers with this many cards are still in the minority, but experts say that the majority of U.S. citizens have at least one credit card -- and usually two or three. It's true that credit cards have become important sources of identification -- if you want to rent a car, for example, you really need a major credit card. And used wisely, a credit card can provide convenience and allow you to make purchases with nearly a month to pay for them before finance charges kick in.

That sounds good, in theory. But in reality, many consumers are unable to take advantage of these benefits because they carry a balance on their credit card from month to month, paying finance charges that can go up to a whopping 23 percent. Many find it hard to resist using the old "plastic" for impulse purchases or buying things they really can't afford. The numbers are striking: In 1999, American consumers charged about $1.2 trillion on their general-purpose credit cards.

In this article we'll look at the credit card -- how it works both financially and technically -- and we'll offer tips on how to shop for a credit card. (Experts say this should be a project on the scale of shopping for a car loan or mortgage!) We'll also describe the different credit-card plans available, talk about your credit history and how that might affect your card options, and discuss how to avoid credit-card fraud -- both online and in the real world.

Let's start at the beginning. A credit card is a thin plastic card, usually 3-1/8 inches by 2-1/8 inches in size, that contains identification information such as a signature or picture, and authorizes the person named on it to charge purchases or services to his account -- charges for which he will be billed periodically. Today, the information on the card is read by automated teller machines (ATMs), store readers, and bank and Internet computers.

According to Encyclopedia Britannica, the use of credit cards originated in the United States during the 1920s, when individual companies, such as hotel chains and oil companies, began issuing them to customers for purchases made at those businesses. This use increased significantly after World War II. The first universal credit card -- one that could be used at a variety of stores and businesses -- was introduced by Diners Club, Inc., in 1950. With this system, the credit-card company charged cardholders an annual fee and billed them on a monthly or yearly basis. Another major universal card -- "Don't leave home without it!" -- was established in 1958 by the American Express company.

Later came the bank credit-card system. Under this plan, the bank credits the account of the merchant as sales slips are received (this means merchants are paid quickly -- something they love!) and assembles charges to be billed to the cardholder at the end of the billing period. The cardholder, in turn, pays the bank either the entire balance or in monthly installments with interest (sometimes called carrying charges).

The first national bank plan was BankAmericard, which was started on a statewide basis in 1959 by the Bank of America in California. This system was licensed in other states starting in 1966, and was renamed Visa in 1976.

Other major bank cards followed, including MasterCard, formerly Master Charge. In order to offer expanded services, such as meals and lodging, many smaller banks that earlier offered credit cards on a local or regional basis formed relationships with large national or international banks.

How does a security passcard work?

ecurity passcards are often used to gain entry into areas and buildings with restricted access. The security passcard may be for general access, meaning that the passcard does not provide data about the person using it, or it may be individually encoded, containing specific information about the cardholder.

Typically, the data on an encoded security passcard includes:

    * Name
    * ID # (social security number or other unique number)
    * Access level (where you're allowed to go)

An individually-encoded passcard looks a lot like a credit card. The stripe on the back of the security passcard is a magnetic stripe, often called a magstripe. The magstripe is made up of tiny, iron-based magnetic particles in a plastic-like film. Each particle is really a very tiny bar magnet, about 20 millionths of an inch long. The magstripe on the back of the card is very similar to a piece of cassette tape.

The magstripe can be "written" because the tiny bar magnets can be magnetized in either a north- or south-pole direction. When the polarity of the bars aligns in the same direction, the card is blank. To write data requires a process called flux reversal. Basically, the polarity of a bar is reversed so that the north pole is facing the north pole of the adjacent bar (N-N) or the south pole is facing the south pole (S-S). This causes a change in the magnetic field that can be detected by the card reader. Since there can be two different flux reversals, N-N or S-S, there can be two different information states. This corresponds nicely to the binary system of 1s and 0s used by computers.

Writing the data requires the use of an encoder. The encoder has an electromagnet that acts as the encoding head. The solenoid is shaped like a ring with a small piece missing. The two ends, north pole and south pole, face each other across this gap, creating a magnetic field. This field varies in strength with the level of current sent through the solenoid. A change in strength can reverse the polarity of the tiny magnetic bars in the magstripe if they are positioned in the gap of the encoding solenoid. By reversing polarities in a certain sequence, the encoder writes data to the card.

A card reader can understand the information on the magstripe. A reader detects the changes in its magnetic field caused by the flux reversals on the passcard's magstripe. Most readers use one of three methods for reading the card:

    * Swipe reader - You swipe the card through a long, narrow slot that is open at each end.
    * Insert reader - You insert the card into a small receptacle that is just large enough to accommodate the card.
    * Proximity reader - You hold the card in front of the blank face of the reader.

Most general-access cards use a magstripe, but some may have a different method for access. For example, one common alternative is to embed a tiny radio transmitter in the passcard. These cards can be either "active" (containing a small battery) or "passive" (relying on the radio reciever for power). When the card is within a certain distance of the radio receiver, usually just a few feet or even a few inches, the security system confirms the signal being transmitted and provides access to the area or building.