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How does a credit card work?

How does a credit card work?

Credit cards are relatively flexible a way of borrowing, you can buy things 'on credit' and then pay off the card gradually, or in full each month

Many people are nervous about getting a credit card, finding the idea of credit intimidating. On the other hand some people rush into spending on plastic without knowing what they are getting into.

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But credit cards are perfectly simple and with the right knowledge it's easy to use one responsibly. It can even leave your finances in better shape.

What is a credit card?

There are two basic parts to understanding a credit card; the credit (which is a bit complicated) and the physical card (which is quite simple).

The credit bit

Unlike a debit card your credit card spending is advanced to you, and you pay it back later by clearing your balance.

This is like an unsecured loan that you can borrow and pay back whenever you want, the amount you owe at any given moment is called your balance.

The total amount you can borrow is capped (your 'credit limit') and you will need to make a minimum repayment each month.

The card bit

The actual credit card itself is a plastic card with an electronic chip and a magnetic strip that enables it to securely communicate with your bank.

To fight fraud credit cards come with chip and PIN protection and most now offer contactless payments too.

Cards payments are mainly processed by Visa, Mastercard or American Express on behalf of banks and other lenders.

What is credit?

Credit is unsecured lending, which means you don't have to offer any security like a house or a car to borrow money.

This means it's offered against your 'credit score', which is a method of deciding how reliable you are as a borrower. The better your score, the more you'll be able to borrow and the lower the interest rate you'll be able to get.

how does a credit card work?

How much does a credit card cost?

The biggest cost to understand is interest rate. This is how much your credit will cost you. For example if you want to borrow £1,000 with your credit and the rate is 15% it will cost you £150.

However, the interest rate applies to the entire year (which is why it's called Annualised Percentage Rate, or APR). It will only cost you £150 if you take a whole year to pay back £1,000.

On a monthly basis it will cost 15 ÷ 12 = 1.25. So borrow £1000 at 15% APR costs £12.50 per month. To see how much card debt costs use our calculator:

There are other costs:

  • Late payment fees
  • Foreign transaction fees
  • Balance transfer fees
  • Cash advance fees

What should I use a credit card for?

On the simplest level they're meant to be used to spend, particularly where you need to spend before you have the cash (so before payday for example).

You also need to note that your credit is not really meant to be used as cash, so you should not use a credit card to withdraw money from a cash machine, as this incurs quite expensive charges.

The most sensible way to use your credit card is for spending on things like:

  • One-off big purchases - sofas, TVs, white goods etc...
  • Supermarket/high-street store spending
  • Online shopping
  • Hotel bookings
  • Flights

It is also useful to use a card for these purchases because you would benefit from payment protection. For more information, read our guide on what you should buy with your credit card.

However, there are different types of credit cards designed to do different things, ranging from cash loans to debt consolidation. You should make sure you get the right card for what you need.

What types of credit cards are there?

There are credit cards to suit all needs, from cards for those with billions in the bank to cards for people who need to fix up their credit score.

  • Purchase cards - Designed for buying things with, many offer 0% interest introductory periods.
  • Balance transfer cards - These cards can hold the balance from other cards and give you a break from paying interest.
  • Money transfer cards - Designed to give a cash loan, typically used to pay off overdrafts or other loans.
  • Credit-builder cards - Cards aimed at those with poor credit scores to rebuild their credit.
  • Credit cards for bad credit - If you have poor credit these cards enable you to borrow money for a higher price.
  • Low APR cardsThe cheapest cards for long term use and sustained borrowing.
  • Travel credit cardsCredit cards with low or no foreign transaction fees and frequent flyers rewards.
  • Reward cards - Credit cards help you earn loyalty points for merchandise, travel and discounts as you spend.
  • Cashback cards - Cards that give you a percentage of the amount of money you spend back as cash.

How do you get a credit card?

Getting a credit card is simple. You can apply for many online, or you can get one from a highstreet bank if you'd prefer.

Typically, you have to:

  • Be over 18
  • Be a UK resident
  • Have a minimum guaranteed annual income (usually £10,000+)

But these are only the bare essentials requirements of your typical credit card and the eligibility criteria varies between cards.

1. Check your credit score

You don't have to but your credit score decides the cards you can and cannot get. Knowing it advance can help you decide if you should apply for a card. If you're apply for a card and get rejected it will leave a mark on your credit file.

2. Compare credit cards

Credit cards are not born equal. You can get better interest rates, longer 0% interest periods, lower fees, better customer service, and more cashback from different card providers, so shop around before you decide on a card.

3. Apply for a card

Fill out the online form or the paper form in a bank branch. Usually you are told instantly whether you've been accepted, but it could take a little longer. You may have to sign some paper forms, but many online providers accept an e-signature.

If you are rejected for a card, rather than applying for another card, you should take a look at your credit score and consider applying for a bad-credit credit card.

4. Wait for it to arrive in the post

Your credit card will be mailed to you and your PIN number will be sent shortly after. You can then start spending with your card.

5. Arrange monthly repayments

Make sure to arrange to meet at least your minimum monthly repayments (typically £5 or a percentage of the total you owe, but some cards require you repay your balance in full each month). If you don't you will face late payment fees and your credit file will be affected.


What's a good first credit card?

This all depends on your financial situation and credit score. You should aim to get a card with the lowest APR possible, or if you plan to pay off your balance in full every month you should find a card that offers the best rewards or cashback.

If you have no history of borrowing you may have a low score, which means you may have to start with a credit builder card, which tend to  have higher interest rates. But if you use this card responsibly your score should improve within a year or so.

If you would like to learn more about the advantages and disadvantages of credit cards before signing up then take a look at our dedicated guide.

How to use a credit card responsibly

Whilst credit cards are nothing to be afraid there are still risks involved.

Firstly make sure you can at the very least meet the minimum monthly repayments. If you consistently miss repayments your credit score will suffer making it difficult to borrow in the future.

Also whenever possible make more than the minimum repayments. You should always aim to clear your card balances as soon as you possibly can, or before any 0% interest periods expire. This will save you a lot of money on interest charges. If you are struggling with credit card debt our guide on getting out of debt may be useful.

Whilst it may be tempting to splurge and max out your credit limits, resist spending more than you can afford to repay. You don't want to be caught in a situation where your interest charges are piling up.

If you're still baffled by credit cards then head over to our guide 'Questions about credit cards' to see if your questions can be answered.

Compare credit builder cards

Find a credit card designed to help you improve your credit rating.

Compare credit cards

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