If you’re new to credit cards, the idea can be daunting. Yet used correctly, they can provide valuable free protection, a chance to build your credit rating, and special 0% deals offer the cheapest way to borrow. This guide explains how credit cards work, the different types available, and what to watch out for so you don’t get burnt.
A credit card lets you pay for things, but rather than taking money from your account each time you spend, the credit card company pays and sends you a bill for it all each month. If you pay this off in full, you’ll pay no interest. The term ‘credit card’ is therefore not very helpful, and is better understood when called a ‘debt card’ or ‘borrowing card’. Any spending on the card is actually running up a debt that you need to pay back.
If you opt to pay a smaller amount, this is carried over to the next month and you’ll be charged interest on the whole balance until you repay it. This is where credit cards can become expensive if you’re not careful.
Five Key Things You Need to Know
1. You’ll need to pass a credit check
As with all types of borrowing, you’ll need to pass a credit check to get a credit card. This lets the lender work out how ‘risky’ you are to lend to, and takes into account your income and other financial commitments. The criteria differs between lenders, so you could be accepted by one but declined by another. Any application will leave a mark on your credit report, even if declined, which could impact your ability to get future credit if there are multiple applications in a short time period.
2. You’ll be given a credit limit
All cards come with a credit limit, which is the maximum amount you can borrow at any one time. The limit is set by the provider based on factors such as your income and credit history, so you usually won’t know how much you’ll get until you’ve been approved. You can request for your limit to be reduced, and in some cases increased, though you’d usually need to have used the card for a few months first. Don’t spend more than your credit limit or you’ll likely be hit with charges.
3. Always pay at least the monthly minimum
Each month your credit card provider will send you a bill listing all your spending for that period. There will be a total balance and a minimum repayment listed, along with a due date. Most cards waive interest on spending if you pay the money back in full and on time. However where you can’t, always pay at least the minimum amount. Failure to pay this means you’re effectively breaking the contract and, in addition to a late fee of around £10, it will be marked as a missed payment on your credit file for up to six years.
To ensure you don’t miss it, set up a monthly direct debit to automatically pay off at least the minimum amount. Be warned though: paying only the minimum is costly and can take years to clear the card.
4. You’ll pay interest if you don’t clear the balance in full
For purchases, if you don’t clear the card in full, your credit card provider will start charging interest. This is usually on the full statement balance and from the date you made each payment. For example, if your bill was £400 and you paid off £350, leaving £50 outstanding, you would still be charged interest on the full £400 until fully repaid.
Cash withdrawals are treated differently and you’ll usually pay interest immediately, sometimes at a higher rate. Some cards will also charge you a fee for taking out cash, often around £3 each time. The interest rate is calculated as an APR (annual percentage rate). A rate of around 21% to 25% is typical, though this can run as high as 60% for those with poorer credit scores.
5. Your credit card usage impacts your credit file
Certain credit card activity is reported and visible on your credit report, including how many cards you have, your credit limits, and the amount you owed when the card company last sent an update. Importantly, it also records your repayment history. If you pay at least the minimum on time, this will generally have a positive impact on your score. However, any missed payments, exceeding your credit limit, or frequently using the card to withdraw cash will usually have a negative impact, as you could be deemed a risk to lend to.
Pros and Cons of Credit Cards
Credit cards are often demonised, and rightly so when used wrong. Yet used correctly, they offer significant benefits. If you don’t have a credit card because you’ve been burnt in the past or don’t trust yourself with one, then don’t touch them. But if you don’t have one because you think they’re all bad, think again.
Pros:
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Extra protection on purchases - Anything you buy on a credit card that costs between £100 and £30,000 is given Section 75 protection, which means the card firm is jointly liable with the retailer if something goes wrong. This is hugely powerful protection if a retailer goes bust or won’t play fair.
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Can offer cheap borrowing or rewards - Some cards offer 0% interest, while others pay cashback or reward points. A credit card used right can save or make you hundreds of pounds. Pay it off in full each month and you’ll never pay interest.
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Can boost your credit score - A well-managed credit card (staying within the credit limit and paying at least the minimum on time every month) can improve your credit score as it evidences your ability to repay. This can lead to lower rates or greater chances of acceptance for other products like mortgages.
Cons:
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Avoid if you already struggle with debt - If you know you couldn’t trust yourself not to spend more than you could afford to repay, a credit card may do more damage than good.
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Beware the minimum repayment spiral - You must pay at least the minimum repayment, but doing only this means interest mounts up quickly. Always have a plan to pay back the balance.
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Can wreck your credit score for years - A badly managed credit card (missing payments and exceeding the credit limit) can damage your credit score and tarnish your credit file for up to six years.
Different Types of Credit Card
Credit cards can do different things, so it’s important to get the right card for what you need.
Balance transfer cards shift existing card debt to 0% interest. You get a new card that repays debts on other cards for you, so you owe it instead but at 0%. This means you’ll be debt-free quicker as repayments go towards clearing the actual debt, not interest. There’s usually a one-off fee as a percentage of the amount transferred. The golden rule: clear the card or transfer again before the 0% ends, or the rate soars to typical 23-25% interest.
0% spending cards offer a number of months where no interest is charged on new spending. Done right, there’s no cheaper borrowing, but they’re not an excuse to overspend. Use them for a needed, planned and affordable one-off purchase like replacing a broken fridge.
Cashback and reward cards give you cash or loyalty points when you spend. As long as you repay in full each month, you neuter the ‘debt element’ of the card and just have plastic that pays you to spend on it. Never use these cards if you can’t clear the balance in full, as the interest will wipe out any rewards.
Travel credit cards offer near-perfect exchange rates on overseas spending. Usually if you pay on plastic abroad, the card firm adds a 3% non-sterling transaction fee. Specialist travel cards waive this fee, so you get the same rate the bank does. Again, clear in full each month or interest wipes out the gains.
Money transfer cards let you pay cash into your bank account for a small fee, with 0% interest for a set period. This is usually much cheaper than loans for amounts under £3,000. Useful if you need to borrow but the retailer doesn’t accept cards, or if you’re paying interest on an existing overdraft.
Credit building cards are designed for those with little or bad credit history. When used for normal spending and paid off in full every month, they can help build or rebuild your credit score. Be careful though: interest rates on these cards can be as high as 60% APR, so clearing in full is essential.
Three Golden Rules for Any Credit Card
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Always repay in full each month, or before the end of the 0% period if you have one.
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Make at least the minimum monthly repayments or you’ll be charged fees and risk damaging your credit score.
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Don’t spend what you can’t afford to repay - you’ll need to pay it off eventually, and the longer you take, the more you’ll pay in interest.
Frequently Asked Questions
Should I pay off my credit card in full every month?
Yes. Paying off in full means you’ll pay no interest. If you fail to pay even a single penny, you’ll be charged interest on the full amount. The only exception is if you’ve got a card with a 0% interest period, but even then you must make the minimum monthly repayments.
What happens if I miss a credit card payment?
If you fail to pay the minimum monthly repayment, it goes down as a missed payment. You’ll be issued with a late payment fee of around £10 and could lose any promotional 0% period. Your provider will report it to credit reference agencies and it will go on your credit file for six years, negatively impacting your chances of getting credit in future.
Can I get a credit card with no credit history?
It can be tricky, as lenders have no information to determine whether you’d be a responsible borrower. There are special credit building cards designed for those with poor or non-existent credit histories which, if used properly, can help you improve your creditworthiness.
How do I cancel a credit card?
First, pay off any remaining balance and cancel any regular payments. If you have reward points, spend them before cancelling. Then contact your card provider to initiate cancellation. It can take up to 60 days to complete. Once confirmed, cut up your defunct card.
How does a credit card affect my credit score?
It can help or harm, depending on how you use it. Never missing a payment and not taking out too much credit can improve your score. Missed payments stay on your credit file for six years and potentially harm your chances of getting credit in future. Even applying for cards leaves a mark on your file, so check your eligibility before applying.
The bottom line is that credit cards are a tool. Used correctly, they offer protection, rewards, and a way to build your credit history. Used incorrectly, they’re a fast track to expensive debt. Know which type of user you are before you apply, and always follow the golden rules.