Quite simply, a credit card allows you to pay for things 'on credit', which means you borrow the money from the credit card provider. Each month you will be given a credit card bill, which will outline the money you have spent on the card and the amount you need to pay back. There is typically a minimum amount you are required to repay, but it is recommended to pay the total balance off in full each month as this means you don't have to pay any interest. If you miss repayments, credit card debt can quickly spiral and become increasingly expensive. In this article we will explain what a credit card is, how it works and run you through the pros and cons.
What is a credit card?
A credit card is a payment card that you can use to make purchases in person or online. The money you initially spend is credit, borrowed from the card provider. It does not come from you bank account, like it would if you bought something with a debit card. Failing to pay off your credit card debt at the end of the month means what you owe will grow with interest. The exception to this is if you have a 0% purchase credit card, which would come with an initial period when you don't have to pay any interest.
A credit card can therefore be a useful tool to manage your finances. For example, you could use the interest-free period to spread the cost of an expensive purchase. You can read our ‘Compare the best 0% purchase credit cards’ article to find out more about this kind of spending.
Credit card users can also benefit from earning rewards through spending with their card. These rewards could be air miles, vouchers, reward points or cashback on purchases. You can find the best rewards cards on our ‘Best rewards credit cards in the UK' page.
Despite these advantages, credit cards can be dangerous and can lead to spiralling debts and financial hardship if they aren't managed properly. You are not spending your own money when you use a credit card. You are taking on debt and will need to pay back what you owe. If you are struggling with debt, a credit card may not be the right option for you. We have information on how to get free debt advice in our article ‘Where to get free debt advice’.
Learn more about whether to apply for a credit card or not by reading our article 'Should I get a credit card?'.
How does a credit card work?
You may be offered a credit card by your bank or you may choose to apply for one from another provider. Once you have a card you will typically be able to use it in most shops and online retailers, in much the same way as you would with a debit card. It is important to keep in mind that each time you use your credit card to pay for goods or services, you are taking on debt and will need to repay the money in the future. You will also not be able to withdraw cash without incurring significant extra charges.
Credit card limits
The provider will set a credit limit when you take out a credit card. This is the maximum amount you are able to spend on the card. This amount will be decided by how 'creditworthy' the card issuer thinks you are, which is determined by how likely they think you are to repay the debt. The credit limit could be a few hundred pounds or could stretch to several thousand pounds, but this amount typically increases if you build up a good credit history of using credit cards responsibly. Once you have reached the limit, you won't be able to buy anything else with the card until you have paid off some of the existing balance. If you exceed the limit, you are likely to be charged a fee as a penalty.
Credit card bills
Your card provider will send you a bill each month, either in the post, via email or through online or mobile banking. It will state the outstanding balance on the account, the minimum amount you need to repay and the date by which you need to make that payment. If you repay the total amount each month, you won't have to pay anything extra. If you pay off only part of the balance, you will be charged interest on the remaining debt, unless you are in an interest-free offer period.
Your provider will give you information on how to pay your bill. You can usually transfer money from your bank account or set up a direct debit so the balance is paid off automatically each month.
What is the difference between a credit card and a debit card?
While a credit card and a debit card look identical, a credit card represents a way of borrowing money to fund purchases, while a debit card is a way of accessing money you already have in your bank account.
It is possible to get into debt with your debit card by spending more than is in your account and going into your overdraft. If this is the case, it is worth considering what interest is payable on your overdraft compared with your credit card when making a purchase.
The other key difference between credit and debit cards is what happens when you use them to withdraw cash from an ATM. While you won't be charged by your bank for taking money out from a cash machine with a debit card, there is typically a hefty charge for doing so using a credit card, sometimes as much as 4%. You will also be liable to pay daily interest on the cash you withdraw and this could be at a higher rate than you would be charged for using the card to make a purchase.
How much does a credit card cost?
The majority of cards don't charge a monthly or annual fee for having the card, with the exception of a handful of premium cards. This means the main cost that is incurred from having a credit card is through the interest you pay on your spending. This will vary from card to card and will be represented as an Annual Percentage Rate (APR). This is the annual rate you will pay in interest and charges, represented as a percentage of the amount borrowed.
All credit cards will provide a representative APR, which gives you a clear point of comparison when you are considering which card to get. The actual interest rate you are given by the credit card provider may change after you have applied, depending on your personal circumstances. You can learn more by reading our article 'What is representative APR?'.
What types of credit cards are available?
There are a wide variety of credit cards available, with different cards offering different benefits. The one you choose will be determined by how you plan to use it, but the main categories are:
- Balance transfer credit cards - for those with an existing debt which they want to move to a card, perhaps with a lower interest rate
- 0% purchase credit cards - for those looking to make a large purchase, such as a holiday
- Money transfer credit cards - for those who need to transfer money to their bank account
- Credit-builder credit cards - for those with little or poor credit history
- Cashback and reward credit cards - for those looking to earn rewards or perks through their spending
- All-round credit cards - for those looking to combine the benefits of a number of features in one multipurpose card
For more information on the types of cards that are available and some pointers on how to find the best option for you, read our article 'How to choose the best credit card for you'.
How can I get a credit card?
The first step in getting a credit card is researching which is the best card for you. In doing so, you should consider:
- how are you going to use your credit card?
- does it have any introductory offers?
- what is the interest rate?
- are any perks or benefits?
The next step is finding out whether you are likely to be accepted for the card, as not everyone will be able to get every card that's on the market. Success will be largely based on your credit record, which will show the credit card provider how likely you are to be a good customer. In other words, the provider will want to know if you are likely to make payments on time and not exceed your credit limit.
Not all card providers have the same criteria when they are considering whether to accept your application for a credit card. You may get rejected for one, but accepted for another. However, it is important not to make multiple applications for a variety of cards over a short period of time, as this will have a negative effect on your credit record. Instead, many card companies have an online eligibility checker, which allows you to see whether you are likely to be accepted without it featuring on your credit file.
For tips on how to improve your credit rating, read our article 'How to improve your credit score quickly'.
Does a credit card offer consumer protection?
An often underestimated benefit of paying by credit card rather than by cash, debit card or through a third-party such as PayPal, is the consumer protection it offers on purchases over the value of £100. This is down to section 75 of the Consumer Credit Act. It applies to goods and services costing more than £100 but less than £30,000 and protects you if:
- the product you bought is faulty
- the product isn’t the same as the description
- the product or service is not delivered as promised
- the trader or retailer goes bust
More information can be found in our article, 'Section 75 of the Consumer Credit Act explained - your rights and how to claim'.
Pros of credit cards
- Offer added consumer protection if there is a problem with a purchase over £100 (and under £30,000).
- Can be used to improve your credit score if you build up good habits and always make payments on time.
- Often have attractive introductory offers that can help you spread the cost of purchases or pay off other debt without having to pay extra interest.
- You can use an eligibility checker before you apply to see how likely your application is to be successful.
Cons of credit cards
- Interest owed will compound quickly if you don't keep up with the monthly repayments. This can affect your ability to secure other borrowing in the future and leave you in serious debt.
- Fees and charges associated with the card can be expensive, particularly if you plan to use it to withdraw cash.
- You may not be accepted for the credit card you want, or get the interest rate you hoped for.
Should I get a credit card?
Although millions of credit cards are issued every year in the UK, it doesn't mean they are suitable for everyone. If you are considering getting a credit card you need to be aware that it is a form of debt. Try to manage your spending carefully and ensure you pay off as much of the balance as possible each month.
You can learn more in our article 'Should I get a credit card?'.