What is a credit card?
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.
A credit card can be a useful tool in managing your finances, especially as they often have introductory offers, such as cashback and rewards as well as an extended period of time to make a repayment without having to pay interest. However, they can also be dangerous and can lead to unmanageable debts and financial hardship if they aren't managed properly.
In this article, we explain exactly how a credit card works, outline the points you need to consider before applying for one, as well as discussing the advantages and disadvantages of this payment method.
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.
Credit card limits
When you take out a credit card, the provider will set a credit limit, which 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 as you build up a good credit history of using the card 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
As discussed previously, the 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, however, 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.
You will be given advice on how to make payment on your bill, but generally, you can 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 and debit card?
While a credit and debit card look identical to each other, 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.
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
- 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/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 you are 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, making payments on time and not exceeding 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. It is, however, vitally 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 of 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
- they offer added consumer protection if there is a problem with a purchase over £100 (and under £30,000)
- credit cards can be used to improve your credit score if you build up good habits and always make payments on time. This could help secure future borrowing at preferential rates
- they 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
Cons of credit cards
- if you don't keep up with the monthly repayments you can quite quickly get into trouble, with the interest owed compounding, resulting in you becoming overwhelmed by the debt. This can have serious consequences on your financial future and could impact your ability to secure a mortgage or other borrowing in the future
- you need to be aware of any fees or charges associated with the card, particularly if you plan to use it to withdraw cash or when you are abroad
- you may not be accepted for the credit card you want, although the risk of this happening and harming your credit score can be mitigated by using an eligibility checker
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 and so you should manage your spending on it carefully, ensuring you pay off as much of the balance as possible each month.