Credit Cards
The Good, The Bad, and the Ugly
Judith Walker
History
• In the US first used in the 1920s to sell fuel to the growing number of car owners
• In 1938 companies started accepting each other’s cards
History
• Concept of paying merchants using a card developed by Ralph Schneider and Frank X. McNamara in 1950 to consolidate individual cards
• Diners Club produced the first charge card
• The BankAmericard was developed in 1958 and evolved into Visa
• MasterCard was introduced in 1966
Different Card Types
• Debit Card– Card directly connected to an account where
money is removed directly from that account
• Credit Card– Card issuer lends consumer money not in an
account, can revolve balance
• Charge Card (≠ Credit Card)– Similar to credit charge except in must be paid
in full each month
Merchants
• Second most secure form of payment – Most secure is cash in hand– Issuing bank commits to payment at the
moment of verification
• Merchant charged commission for the privilege of the service
• It is a privilege to be able to accept credit cards and it can be removed due to violations by the merchant
Number System
• The first digit in your credit-card number signifies the system: – 3 - travel/entertainment cards (Amer. Express & Diners Club) – 4 - Visa – 5 - MasterCard – 6 - Discover Card – Phone companies, gas companies and department stores have
their own numbering systems
How They Work – Consumer
• Consumer is approved for a certain level of credit based on income and credit history
• Electronic verification system (magnetic strip) verifies card validity and if there is sufficient credit to cover purchase
• Statement sent each month to consumer with total balance and payment requirements
Magstripe
• Magstripe – the magnetic strip on the back of the card– made up of tiny iron-based magnetic particles in a plastic-like film. Each
particle is really a tiny bar magnet about 20-millionths of an inch long
– The magstripe can be "written" because the tiny bar magnets can be magnetized in either a north or south pole direction. The magstripe is very similar to a piece of cassette tape
Credit Card – Pin
• PIN – personal identification number– The PIN is not on the card – it’s encrypted
(hidden in code) in a database– The PIN can be either in the bank's computers in
an encrypted form or encrypted on the card itself – The transformation used in this type of
cryptography is called one-way– This feature was designed to protect the
cardholder from being impersonated by someone who has access to the bank's computer files
Interest
• Pay in full each month, no interest accrued
• Not paid in full– Typically full interest on the entire outstanding
balance each month from the date of purchase if the balance is not paid
– Interest rates will jump drastically if late with just ONE payment
• In some cases rates will double• Often delinquency will result in rates of 25-30%
Interest
• 4 common methods of charging interest– Detailed in Regulation Z of the Truth in
Lending Act• Average Daily Balance
• Two-Cycle Average Daily Balance
• Adjusted Balance
• Previous Balance
• The UK uses the Daily Accrual method
Incentives
• Frequent Flyer Miles
• Gift certificates
• Cash back (usually
one 1%)
• Donation to charity or
cause
– Environmental
– National Geographic
Credit Score
• Three-digit rating that
estimates how
‘trustworthy’
concerning
repayment
• Affects loan
qualification, credit
limits, interest rates
FICO Score
• Best known US credit score– Developed by Fair Isaac Corporation
• Use a statistical model to generate a score and compare with other individuals with similar history
• Models subject to federal regulation– Regulation B
• Specific reasons must be given for denial
FICO Credit Score
punctuality ofpayment
capacity used
length of credithistory
types of creditused
recent credit
FICO Score Components
• Exact distribution
closely guarded
• 35% punctuality of
payment
• 30% capacity used
• 15% length of history
• 10% types of credit
• 10% recent credit
search/obtained
FICO Score
• Current income and
employment history do
not factor into the score
but are weighed when
applying for credit
• Range from 300 to 850– US median around 725
– Score >720 good
– Score <600 poor
How to Improve Credit Score
• Check report for accuracy
• Pay on time
• Clean up derogatory statements
• Decrease capacity used
• Establish a credit history
• Minimize damage in difficult times
• Limit credit inquiries
Secured Credit Cards
• Credit card secured by a deposit account owned by the cardholder– Generally 100% to 200% of the desired credit– Still make payments as if it was a regular
credit card– Default on payment, lose security and can
accrue additional debt due to interest
• Sometimes the only option to rebuild credit
Fair Credit Reporting Act
• American Federal Law– 15 U.S.C. § 1681
• Regulates the collection, dissemination, and use of consumer credit information
• Regulates credit reporting agencies
• In 2003 the act was amended to guard against identity theft
Credit Card Fraud
• The type of fraud where a merchant is accepts a card under the assumption the account will provide payment
• Later the merchant does not receive payment or it is reclaimed by the issuing bank
• Today half of all credit card fraud is conducted online
Types of Fraud
• Mail Non-Receipt– Theft of mail containing a replacement card
• Chargeback Fraud– Bank notified that illegal purchases were
made and they charge payment is taken back from the merchant
• Skimming– Merchant copies the magnetic strip illegally
Fraud Prevention
• Card-Present
– Signed receipt that
matches signature on
back of the credit card
– Show photo
identification
– Checking the last 4
digits on the card