How Do Credit Cards Work? Explained

Credit cards

20.03.2025

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Credit cards have become a valuable financial tool to help you make urgent payments and build your credit score. Roughly 2.8 billion people have credit cards, which make up 35% of the world’s population. Total credit card transaction value exceeded $3.5 trillion in 2024. Credit cards serve as a gateway to financial freedom, which can be quite deceptive sometimes. Getting access to the revolving line of credit can work well if used wisely. This is why understanding the mechanism behind the piece of plastic is required to manage your finances with confidence. So, how do credit cards work? Read this article to get a detailed answer.

What Is a Credit Card?

A credit card is a financial settlement between the cardholder and the issuer. It allows you to borrow money up to a certain limit and then make a full reimbursement over time. Most credit companies check your financial rating to understand your ability to make full repayment. They use this knowledge to decide about lending money. The key players in a credit card transaction include:

• Cardholder: The individual or business uses the card for purchases.
• Issuer: The bank gives the physical credit card and then watches over the account.
• Merchant: The business accepts credit payments for goods or services.
• Payment processor: A company helps ease transactions between the merchant and the issuer, and guarantees safety.

What are credit cards used for? They are used for online shopping, travel bookings, insurance bills, and other purposes. They offer financial flexibility, allowing you to collect funds and pay them back later.

How Credit Cards Work: The Transaction Cycle

You can compare using a credit card to taking out a personal loan, which allows you to receive a specific sum once and repay it within a set timeframe. Understanding how this financial tool works may help you use it responsibly, earn potential rewards, and avoid getting trapped in debt.

Step-by-Step: How Does a Credit Card Work

Making a purchase with a credit card takes several seconds. The process may look simple, but it involves a huge number of events. Here is what the transaction looks like:

• The cardholder or buyer uses a credit card to pay for the merchant’s product or service. A card can be scanned, inserted, or inputted by hand.
• The merchant sends a verification request through the payment processor to the cardholder’s issuing bank. A request needs to be authorized after a thorough check.
• The payment gateway collects payment data and sends it to the payment processor. It protects cardholder data from unauthorized access.
• The payment processor gets the merchant’s verification message and sends it to the related network (Visa or MasterCard).
• The network gets the card details from the payment processor and sends them to the cardholder’s issuer for further authorization. It serves as a bridge between the processor and the issuer.
• The issuer checks the payment details against the cardholder’s line of credit and then authorizes the financial operation. The issuer then transfers its feedback to the network.
• The network forwards the issuer’s feedback to the payment processor.
• The payment processor forwards the issuer’s feedback to the merchant’s payment platform.
• The merchant receives the issuer’s feedback and provides a receipt. This marks the completed operation.

Once the initial transaction is settled, the banks and networks still have things to do. Credit card processing fees must be covered by the service provider. Once done, the retrieved funds make their way to the merchant’s balance.

Types of Credit Cards

What does a credit card do? Generally, it allows users to borrow money from a bank or issuer to make purchases, pay bills, or withdraw cash. Here are different types of credit cards, each coming with approved features:

• Secured credit cards are suitable for individuals with missing or bad credit history. They serve as regular credit cards, which allow users to make purchases and build financial records. To qualify, users need to make a refundable security deposit as collateral, which usually determines the credit limit. Issuers report payments to credit agencies, which makes it easier for cardholders to claim unsecured cards over time.
• Unsecured credit cards are suitable for individuals with a good financial history. They don’t require users to lock up any funds. The card issuer approves or denies your application based on your current rating. These cards may have higher credit limits but also higher interest rates and service fees.
• Student credit cards are meant for college students who have no credit history. They come with lower credit limits, fewer service charges, and even cashback on purchases. These cards help students build their credit rating by reporting payments to credit agencies.
• Store credit cards are issued by retailers and can be used for making purchases on that retailer’s website or store. They have higher interest rates but help build a credit score when used responsibly. Their approval comes easier compared to classic cards from credit issuers.
• Rewards credit cards offer special points, cashback, or miles for purchases. Rewards can be redeemed for travel, statement credits, or gift vouchers. Categories may include groceries, dining, gas, or general expenses. These cards often have higher interest rates and fees to be paid monthly or annually.
• Business credit cards are used by small entrepreneurs to manage expenses and build a positive financial record. They provide benefits that align with business needs, such as rewards for buying employee cards. They also come with higher credit limits but may require a guarantee that the owner is liable for unpaid balances.

Credit Cards and Credit Score

When submitting your credit card application, the issuer makes a hard inquiry into your financial record. This may reduce your score by several points, which will remain on your credit report for two years. How a credit card works? It reflects a person’s creditworthiness, which helps build a strong credit score. Making timely payments is the key condition for having a credit score. Payment history is the most crucial factor because it makes up 35% of the score.

Credit utilization also has a direct impact on the score. Keeping the utilization level below 30% is required for a positive effect. When you become more confident using a credit card, ensure to keep your credit utilization as low as possible.

Having extensive experience with credit can also impact your score. The age of your oldest, newest, and average accounts could be scoring factors as well. Opening a credit card will decrease the average age of your accounts, which might hurt your financial rating. Meanwhile, keeping the account open can be helpful in the long run.

Credit Cards vs. Debit Cards

Many individuals use a debit card before they get their first credit card. They both belong to a payment network and can be used for making purchases. Despite all the similarities, they actually have different functionality. A credit card allows you to borrow money, with the intention of paying it back within a certain timeframe. With a debit card, you can only use the funds you’ve already transferred to the checking account linked to the card. Check the detailed comparison of both products in the table below.

Managing Credit Cards

To manage credit cards effectively, you should develop good spending habits. To achieve the desired level of efficiency, you may require some guidance. Check the main scenarios of using your card.

How to Cancel a Credit Card

Canceling a credit card issued by Discovery is a quick and simple process. It needs you to follow the right steps to avoid a negative impact on your credit score.

1. Pay back your debt. If you don’t pay off your credit balance in advance, you’ll still need to make a credit card payment to the issuer on the closed account.
2. Use the collected rewards. If you don’t want to lose accumulated loyalty points or any other rewards, redeem them before the cancelation deadline.
3. Update your recurring payment account. Enter the relevant card information for automatic credit payments.
4. Inform other cardholders that you want to cancel the account. If your spouse or other family members have access to your credit account, let them know about your overall plans.
5. Apply for cancelation. Contact your provider through the customer service department and make a cancelation request.
6. Get rid of your card. Once your account is canceled, cut up and throw away your card.

Credit Card Decline Codes: What They Mean

Now that you have the answer to your question, “how does a credit card work”, you should be ready to get your transaction declined. A decline code is a notification that pops up on the screen when a transaction does not go through. The decline code makes it easier for the issuer to explain the reason behind the decline to the cardholder. Here are the most common reasons for a decline code:

• Insufficient funds;
• Missed expiry date;
• Address verification issues;
• Fraud detection, etc.

Understanding the meaning of the received code is critical for solving the underlying problem. You may need to contact your credit card company, provide the recent payment details, or take a different card. Make sure to manage your card effectively and keep track of your finances.

How to Get Cash from a Credit Card

Some retailers don’t support credit cards. A cash advance allows you to withdraw cash from your credit card so you can make a payment offline. Here are a few ways of doing it:

• ATM: Insert your credit card into the ATM to access a certain cash amount using your unique PIN. Make a withdrawal based on the set cash advance limit.
• Bank: Visit a bank or credit union to get a cash advance from your credit balance. Prepare your card and a photo ID for a withdrawal.
• Convenience check: Request convenience checks from your card issuing company. Once it’s completed, your credit issuer takes a certain amount from your credit limit.
• Online transfer: Sign in to your bank account to request the cash advance. The requested amount is going to be deposited into your checking account within several days.

Get a cash advance with any Discover Card from partnering banks, ATMs, and credit unions. You can also deposit cash from your card directly into your checking account if you want to request checks online.

Frequently Asked Questions (FAQ)

How do credit cards help my business manage online payments?

Now that you know “how does the credit card work”, your business can use this tool to accept online payments securely through payment gateways (e.g., Stripe, PayPal), merchant accounts, or processors (e.g., Square). These cards offer fraud protection, fast transactions, and global reach, contributing to customer satisfaction and higher sales.

What types of credit card processing are there for online businesses?

Professional online businesses use different credit card processing methods, including gateways (e.g., PayPal, Stripe), corporate accounts, processors (e.g., Square), hosted checkout pages, and API integrations for smooth transactions. Each method offers different security, fees, and customization options.

What is a merchant account, and why do I need one?

A merchant account is a unique bank account that allows businesses to receive payments via credit cards. It is required for processing transactions between consumers and the business’s bank. It also ensures swift transactions and helps manage corporate funds efficiently.

How can I guarantee secure online credit card payments?

To guarantee secure online credit card payments, use secure gateways (e.g., Stripe, PayPal), comply with PCI-DSS norms, enable 2FA, and install fraud detection software on your device. In addition, inform consumers about safe online practices.

What fees do I pay as a merchant for accepting credit cards?

As a merchant, you may pay various fees for accepting credit cards, including transaction fees (usually a percentage per sale), monthly service fees, chargeback fees, and setup fees. Payment processors and merchant accounts may also charge additional fees based on transaction volume, risk, or integration conditions. You can use a calculator to estimate all the charges.