CREDIT CARD

MINI-LESSON

INDIANA DEPARTMENT OF
FINANCIAL INSTITUTIONS
CONSUMER EDUCATION
Copyright, 1996 © Dale Carnegie & Associates, Inc.
 INTRODUCTION

This mini-lesson includes learning objectives,

background information, discussion questions, an
activity, and sources of additional information.
 OBJECTIVES
Learners will:

• learn the types of credit card accounts and the uses

and payment methods of each

• understand how to shop for a credit card

• read and interpret a credit card statement

• understand how to handle billing errors

WHAT IS A CREDIT CARD?
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. It 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.
How Long Have Credit Cards
Been Around?
According to the Encyclopedia Britannica, the
use of credit cards originated in the U.S. during
the 1920s, when individual companies, such as
hotel chains and oil companies, began issuing
them to customers for purchases made at their
businesses. This use increased significantly after
World War II.
 First Credit Card
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 card holders an annual fee and billed
them on a monthly or yearly basis. Another
major universal card -- the one with the famous
TV commercial ("Don't leave home without
it!") -- was established in 1958 by the American
Express Co.
 Bank Credit Card System

Later came the bank credit card system. Under this

plan, the bank credits the account of the merchant
as sales slips are received (this meant merchants
were paid quickly -- something they loved!) and
assembles charges to be billed to the card holder at
the end of the billing period. The card holder, in
turn, pays the bank either the entire balance or in
monthly installments with interest (sometimes
called carrying charges).
 First National Bank Plan
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
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.
 Numbers on a Credit Card
Although phone, gas, and department stores
have their own numbering systems, ANSI
Standard X4.13-1983 is the system used by
most national credit card systems. Here are
what some of the numbers mean:
The first digit in your credit card number
signifies the system -- 3=travel/entertainment
cards (such as American Express and Diners'
Club), 4=Visa, 5=MasterCard and 6=Discover
Card.
 Numbers on a Credit Card
The structure of the card number varies by
system. For example, American Express card
numbers start with 37; Carte Blanche & Diners
Club with 38.
American Express: Digits 3-4 are type &
currency, digits 5-11 are the account number,
digits 12-14 are the card number within the
account, and digit 15 is a check digit.

Visa: Digits 2-6 are the bank number, digits 7-12

or 7-15 are the account number, and digit 13 or
16 is a check digit.
Stripe on the Back of the Card
The stripe on the back of a credit card 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 can be "written"
because the tiny bar magnets can be magnetized
in either a north or south pole direction. The
magstripe on the back of the card is very similar
to a piece of cassette tape fastened to the back of
a card.
 Magstripe Reader
A magstripe reader (you may have seen one
hooked to someone's PC at a bazaar or fair) can
understand the information on the three-track
stripe. If the ATM isn't accepting your card, your
problem is probably either:
• Dirty or scratched magstripe
• Erased magstripe (The most common causes for
erased magstripes are exposure to magnets, like
the small ones used to hold notes and pictures on
the refrigerator, and a store's electronic article
surveillance (EAS) tag demagnetizer.)
 Information Is on the Stripe
There are three tracks on the magstripe. Each
track is .110-inch wide. The ISO/IEC standard
7811, which is used by banks.

Your credit card typically uses only tracks one

and two.
HOW IS THE CREDIT CARD
AUTHENTICATED?
There are three basic methods for determining that
your credit card will pay for what you're charging:
 Merchants with few transactions each month
do voice authentication, using a touch tone
phone.

 Electronic data capture (EDC) magstripe card

swipe terminals are becoming more common
-- so is having you swipe your own card at
the checkout.
 Virtual terminal on the Internet
 How it Works

This is how it works: After you or the cashier

swipes your credit card through a reader, the
EDC software at the point of sale (POS) terminal
dials a stored telephone number via a modem to
call an acquirer. An acquirer is an organization
that collects credit authentication requests from
merchants and provides a payment guarantee to
the merchant.
 How it Works
When the acquirer company gets the credit card
authentication request, it checks the transaction
for validity and the record on the magstripe for:
 Merchant ID
 Valid card number
 Expiration date
 Credit card limit
 Card usage
 Smart Cards
An innovative application that involves all
aspects of cryptography (secret codes) -- not just
the authentication we just described -- is the
"smart" credit card, which has a microprocessor,
or tiny chip, built into the card itself.
Cryptography is essential to the functioning of
these cards. The user must corroborate his
identity to the card each time a transaction is
made in much the same way that a PIN is used
with an ATM. The card and the card reader
execute a sequence of encrypted sign/counter-
sign-like exchanges to verify that each is dealing
with a legitimate counterpart.
 Smart Cards

Once this has been established, the transaction

itself is carried out in encrypted form to prevent
anyone, including the card holder or the
merchant whose card reader is involved, from
"eavesdropping" on the exchange and later
impersonating either party to defraud the system.
This elaborate protocol is conducted in such a
way that it is transparent to the user, except for
the necessity of entering a PIN to begin the
transaction.
 Smart Cards
Smart Cards first saw general use in France in 1984.
They are now hot commodities that are expected to
replace the simple plastic cards most of us now use.
Visa and MasterCard are leading the way in the
United States with their Smart Card technologies.

The chips in these cards are capable of many kinds

of transactions. You could make purchases from
your credit account, debit account, or from a stored
account value that's reloadable.
 WILL I QUALIFY FOR A
CREDIT CARD?
There's no way to know if you'll qualify for a
credit card without doing some research. Some
of the basic things that lenders look for include:

• Good payment record -- If you pay your bills

on time, you'll score major points with lenders.
If you have a lot of late payments, this can hurt
your chances of getting a card, and, if the lender
decides to issue you a card, it's probably going
to have a higher interest rate.
 Qualifying for a Credit Card
• Signs of stability, responsibility -- Lenders
perceive things such longevity in your home and
job (at least two years) as signs of stability.
Having a respected profession doesn't hurt either.
• Control of debt load -- Lenders generally want
to see that you are a good credit risk and that you
aren't living beyond your means. Experts say
non-mortgage credit payments each month
should not exceed more than 10 or 15 percent of
your take-home pay.
 Qualifying for a Credit Card
• Lack of credit inquiries -- Whenever you apply
for a credit card, the lender will pull your credit
report from one or more of the major bureaus as
part of the approval process. Each time a report is
pulled, it's marked as an inquiry and stays on
your credit bureau report for two years. Lenders
perceive several inquiries on your report as
indications that you're scrambling for loans and
may consider you a poor credit risk.
 CREDIT CARD TERMS
When selecting a credit card, the following credit
terms and conditions are important because they
affect the total cost of credit:
• "Annual Fee" A flat, yearly charge similar to a
membership fee, usually $25 to $50.
• "Annual Percentage Rate" The APR is the
measure of the cost of credit expressed as a yearly
rate.
• "Finance Charge” The dollar amount you pay to
use credit, includes interest costs and all charges
associated with the transaction.
 Credit Card Terms
• "Grace Period or Free Period" The grace period is
the number of days you have before a credit card
company starts charging interest on new
purchases. Not all credit cards have a grace period .
• "Periodic Rate" The interest rate the card issuer
applies to your outstanding account balance to
figure the finance charge for each billing cycle.
• "Transaction Fees” A fee for a cash advance, a
late payment, or going over your credit limit.
Sometimes there is a monthly fee if you did not use
the card.
 Credit Card Terms
• "Calculation of Finance Charges” It is very
important to know how the interest rate is
calculated to compare and select the best credit
terms. The credit card issuer will use one of three
methods. You can decide which method is best
suited to your payment style. The method used can
make a big difference in the total amount of money
you pay in finance charges. This is especially
important when the APR's are identical for several
credit cards. There can be a significant difference in
the total amount of finance charges depending on
the balance computation method used.
 Credit Card Terms
• "Average Daily Balance Method” This is the most
commonly used method. You are given credit for
your payment from the day the credit card issuer
receives it and the interest is calculated on the basis
of the average amount owed during the previous
month.
• "Adjusted Balance Method” This method is the
most beneficial to the consumer and produces the
lowest finance charges. The balance is calculated
by subtracting the payments and any refund credits
from the balance you owe at the end of the previous
billing period.
 Credit Card Terms

• "Previous Balance Method” This is the most

expensive method. The finance charge is
calculated on the balance owed at the end of the
previous billing cycle. Payments, credits and new
purchases made in the current billing cycle are not
included.
 How to Choose a Credit Card
• Step 1: Do Some Research -- There are plenty of
places, both online and offline, where you can read
about credit card offerings.
• Step 2: Make a List -- Make a list of credit card
features that fits your financial needs and rank the
features according to how you plan to use the card
and pay your monthly bill.
• Step 3: Review the Plans -- Review all of the
information you've gathered on different plans. Pay
special attention to the APR -- you want a low rate.
 How to Choose a Credit Card
• Step 4: Check Out Credit Unions -- Look
into the possibility of joining a credit union;
they are non-profit, have lower overhead and
so charge lower interest rates.
• Step 5: Compare Plans -- If you already
have a credit card, be sure that you're
making a good move before you swap cards.
 Truth-in-Lending
Disclosures
No matter what kind of card and plan you choose, you should
have access to the following information under the federal Truth
in Lending Act so that you can compare one loan to another:
 Finance charges in dollars and as an annual percentage rate (APR)

 The credit issuer or company providing the credit line and the size of
the credit line

 Length of grace period, if any, before payment must be made

 Minimum payment required

 Annual fees, if applicable

 Fees for credit insurance (if any)
 Types of Credit Cards

There are three basic types of credit cards:

• Travel and entertainment cards such as American
Express or Diners Club. They have no predetermined
spending limits and must be paid in full each month.

• Bank cards such as MasterCard, Visa, Discover,

Optima, GM and Ford cards which are sponsored by
individual banks. The bank defines spending limit
(sometimes called credit lines) and each offers
different terms and conditions.
 Types of Credit Cards
• House cards that are good only in one chain
of stores such as Sears, J.C. Penney, Shell, or
. Mobil. These cards are only accepted by the
specific company and do not have an annual
fee. However, the terms and conditions of these
cards vary widely.

• Affinity card. This card -- typically a MasterCard

or Visa -- carries the logo of an organization in
addition to the lender's emblem.
 The All-Important Plan
Now we come to the core of the credit card selection
process -- which plan to choose. The costs and terms of
your credit card plan can make a difference to how
much you pay for the privilege of borrowing (which is
what you're doing when you use a credit card).
In the disclosure form from the credit card issuer (usually
a small, fine print brochure), look closely at the credit
terms we discussed earlier. Don't forget about specifics
like late charges (usually $15-$30) and over-the-limit
fees (around $20-$25). Consider these factors along
with how you pay your bills each month.
 Variable Rate Plans
Credit card companies that issue variable rate plans
use indexes such as the prime rate, the one, three,
or six-month Treasury Bill rate, the federal funds or
Federal Reserve discount rate. (Most of these
indexes can be found in the money or business
sections of major newspapers.)
Once the interest rate corresponding to the index
has been identified, the credit card issuer then adds
a number of percentage points -- called the margin
-- to this index rate to come up with the rate the
consumer will be charged.
 Fixed Rate Plans
Take a good look at fixed rate plans. They may be
a couple of percentage points higher than a
variable rate, but you will have the advantage of
knowing what your interest rate will be. Variable
rates are just that -- they change -- and can
increase (usually the case) or decrease your
finance charges.

If your rate is fixed, the Truth in Lending Act

requires the lender to provide at least 15 days
notice before raising the rate.
 Example

To illustrate the importance of a low interest rate,

let's look at a simple example:
Plan Terms Plan A Plan B
Average monthly balance $2,500 $2,5
APR . 18% 14%
Annual finance charges $450 $350
Annual fee $20 $0
Total cost $470 $350
 Payments

Some credit cards, such as American Express,

require you to pay off all your charges each month.
As a benefit, they usually have no finance charge
and sometimes, no maximum limit. Most cards,
including Visa, MasterCard, Discover, and Optima,
offer what is known as revolving credit. This means
they let you carry a balance, on which they charge
interest (finance charges), and they require you to
make a minimum payment. The minimum payment
is usually about 3-5 percent of your current balance
or $10 -- whichever is more.
 Payment Example
• High-rate card: Suppose you charge $1,000
on a 23.99% credit card. After that, you
make no further charges and pay only the
minimum each month. The payment will start
at $51 and slowly work its way down to $10.
You'll make 77 payments over the next six
years and five months. By then, you will
have paid $573.59 in interest for your credit
privilege.
 Payment Example
• Low-rate card: If you charge that same
$1,000 on a 9.9% fixed-rate card, the
minimum monthly payment will start at
$50.41 and go down to $10. You'll make 17
fewer payments and pay $176 in interest.
This saves you $397.59!
 Newer credit card charges-

Used by virtually all the companies in the last

decade or so -- are late fees and over-the-limit
fees. And increasingly, credit card issuers are
drastically raising interest rates (to as high as
23.99%) after a set number of late payments
(read the fine print and make sure you know
whether the payment is considered posted on its
postmarked date or on the date the bank or
credit card company gets it posted!).
 Credit Card Statement

A credit card statement provides information such

as how and when you've used your credit card,
how much you owe, how much interest you're
paying to use the card, how much your minimum
payment is, and how much credit you have left.

Knowing how to read your credit card statement

can also help you catch unauthorized charges
and/or billing errors.
 What If There Are Errors on My
Bill?
One way to avoid billing errors and unjustified fees is
to carefully go through your monthly credit card
statement, making sure all the transactions are
legitimate and that other charges -- finance charges,
late, or over-the-limit charges -- are justified.
 Fair Credit Billing Act
The Fair Credit Billing Act applies to credit card and
charge accounts and to overdraft checking (but not
to checks or debit cards). You can use this Act to
defend against billing errors, unauthorized use of
your account, goods or services charged to your
account but not received or not provided as
promised, and charges for which you request an
explanation or written proof of purchase. Here are
some important steps to take when you encounter
one of these problems:
 Billing Errors
• Write to your card issuer or creditor within 60
days after the first bill containing the disputed
charge is mailed to you. (Even if more than 60
days has passed since you were billed for the
item, you still might be able to dispute the
charge if you only recently learned about the
problem.)
• Send your letter to the address provided on the
bill -- do not send the letter with your payment.
 Billing Errors
• In the letter, give your name, account number, the
date and amount of the disputed charge and a
complete explanation of why you are disputing the
charge
• If you follow these steps, the creditor or card issuer
must acknowledge your letter in writing within 30
days after receipt and must conduct an investigation
within 90 days. While the bill is being investigated,
you don't have to pay the amount in dispute. (The
creditor or card issuer is not allowed to take action
to collect the disputed amount, report the amount as
delinquent or close or restrict your account.
 Travel Abroad?
Credit card usage and acceptance vary around the world.
In some countries (including France), Visa and MasterCard
networks have been merged and all merchants who take
one, take them both. On the other hand, the cash advance
networks have not been merged. So, if you are in France,
almost any bank or ATM (if you have a PIN) can give you a
cash advance on Visa, but only a few banks and cash
machines can give you a MasterCard cash advance.

In other countries (such as Italy), Visa and MasterCard

networks have not merged. So, if you're going there, you
might need both.
 Things to do to Protect Credit
Card Accounts
These tips are important and universal:

• Sign your card -- as soon as you receive it!

(Obviously, this only works as well as the
clerk checking it!)

• When you use your card at an ATM, enter

your PIN in such a way that no one can easily
memorize your keystrokes.
 Tips
• Don't leave your receipt behind at the ATM --
your PIN and account number from a
discarded receipt could make you vulnerable
to credit card fraud. Also, don't throw out
your credit card statement, receipts or
carbons without first shredding them!

• Never give your credit card number over the

telephone unless you initiated the call.
 Tips
• Ignore any credit card offer that requires you to
spend money up-front or fails to disclose the
identity of the card issuer.
• Make certain you get your card back after you
make a purchase.
• Always keep a list of your credit cards, credit
card numbers and toll-free numbers in case your
card is stolen or lost.
• Check your monthly statement to make certain
all charges are your own.
 CREDIT CARD
COMPARISON
WORKSHEET
Credit Annual APR Grace Finance Trans Credit Services
Card Fee Period Charge Fee Limit_______

________________________________________
________________________________________
________________________________________
________________________________________
________________________________________
________________________________________
________________________________________
 Discussion Questions
and Topics
1. Explain what the number are for on a credit card.
What is the purpose of the strip on the back of the
credit card.
2. How do merchants authenticate a credit card
purchase.

3. What is a "Smart Care"?

4. What are the qualifications for a credit card?
5. Discuss how costs and features can vary between
credit cards.
 Discussion Questions
and Topics
6. What is the difference between a fixed rate and
a variable rate?

7. What should you do if there is an error on the

credit card billing statement?
 Activity
1. Using the form provided, ask teams of students to
shop for three credit cards (two major credit cards and
one from a local department store). When they've
finished their research, ask them to answer a series of
questions about their findings.

2. When all the teams have finished their research and

completed the questions, have each team explain to the
class how they determined which credit card they would
recommend for purchasing a CD player Have the class
critique the logic each team used to arrive at their
decision.
 Activity
1. Have students apply their findings by making
decisions about the kind of card they would use to
purchase a CD player.

2. Have students take a close look at a credit card

statement and see what information it contains.

3.Using the credit card statement provided, have

students answer the questions on the statement.
Give students a copy of our Brochures.