Used well, a credit card is a secure and flexible way to pay and can be a good way to spread the cost of major purchases. But if you only make minimum payments or run up a bill you can’t pay back, credit cards can be costly. Find out more about how credit cards work, and if they would be the best option for you.
How does a credit card work?
- A credit card lets you spend money on credit – it’s like having a loan for the amount you spend using the card. You can spend up to a pre-set credit limit, which might be a few hundred or several thousands of pounds.
- It depends on how confident your card provider is that you’ll pay it back.
- If you pay off the bill in full each month, you won’t pay interest on what you’ve borrowed. If you make cash withdrawals though, interest is usually charged on a daily basis from the day you take your cash.
- This is one of the reasons why you should avoid taking cash out using a credit card. You’ll be hit with charges – up to 4% or more with some companies. The interest rate for cash withdrawals is also usually higher than for purchases.
- If you don’t pay off any outstanding balance in full then interest will be charged.
- It’s usually backdated too, so if you bought something at the start of the month you’ll be charged a whole month’s interest.
Is a credit card for me?
There are some important points you need to keep in mind before applying for and using a credit card.
- You need to make at least the minimum payment each month, even during an interest-free period. Set up a Direct Debit for the full monthly balance, or for as much as you can afford to repay. This will mean you don’t miss a payment, which could lead to unwanted charges and the loss of any introductory rate. Missing payments could also damage your credit rating.
- You’ll have a credit assessment by the card provider when you apply, which will usually include checking your credit reference file. A good credit rating will improve your chances of a successful credit application. It could also give you access to cards offering the lowest interest rates and/or promotional offers.
- You need to be at least 18 to apply for a credit card. With some cards the minimum age is 21.
Pros of credit cards
- Easy to carry, easy to use. Credit cards are accepted at more places than charge cards and prepaid cards.
- Safer than cash. If your card is lost or stolen, just call your bank and cancel it. If it’s stolen and used fraudulently, you’re much more likely to get the money back.
- Buy now, pay later. If you don’t have the cash you need until your next payday, or for a major purchase, a credit card gives you some extra financial wriggle room – though you should only use it if you’re confident you can pay it back.
- You’re protected. With credit cards, you’re protected for most purchases over £100 and up to £30,000 – so if you book a holiday and the provider goes out of business, the card company should cover the cost even if you only paid an initial deposit by card. This is under Section 75 of the Consumer Credit Act. You might also be protected for smaller purchases that are under £100 with the ‘chargeback’ scheme. Read more about the protection you get with credit cards.
- Freebies often come with credit cards – things like air miles, reward points and cashback. Find out more about Cashback credit cards.
Cash withdrawals cost money
Credit and debit cards work differently at cash machines. Debit cards are mostly free or tell you if there’s a charge.
If you use your credit card you might pay a fee every time you take out cash and you might not be warned of the extra cost when you use the machine.
Fees can be as much as £5 per withdrawal. You’ll also be charged interest on the money, even if you pay it off by your card repayment date.
The same applies to other transactions that are treated as cash – such as using a credit card to purchase foreign currency or gift cards, or make gambling transactions.
With fees and interest, avoiding taking out cash on a credit card is the best advice.
Credit card cheques come with fees
A credit card cheque is like a normal cheque, but the money goes on your credit card bill instead of coming out of your bank account.
- They are expensive - they are treated like a cash withdrawal, so the interest rate is higher and there are additional fees on top.
- Credit card cheques don’t have the same protection for your purchases as card transactions, because Section 75 does not apply.
They’re much less popular now and you have to ask for them from your card provider. As with cash withdrawals, they’re very expensive to use and the best advice is to avoid them.