Credit Cards - A Simple Guide to How They Work

We understand that credit cards can seem a bit confusing if you're not familiar with them. Think of a credit card as a flexible and convenient tool that allows you to make purchases now and pay for them later. It's designed to help you manage your expenses and build a strong credit history.

Plus, credit cards come with some great perks like purchase protection, cashback, and even airline rewards. We’re here to help you navigate these benefits and make the most out of your credit card experience.

What is a credit card?

When you use a credit card to make a purchase, you're essentially borrowing money from your credit card provider, up to a certain limit.

At the end of each month, you’ll receive a statement showing what you owe. You have the flexibility to pay off the entire balance or just a part of it. Keep in mind, that if you choose to pay only the minimum amount or less than the full balance, interest may be added to your remaining balance in the following month.

How do credit cards work?

Using a credit card is similar to using a debit card—just tap your card or enter your PIN. However, with a credit card, you're borrowing money for each purchase, which you’ll need to repay. If you don't pay your balance in full each month, you'll incur interest charges at the offered APR.

What does APR mean?

APR stands for "annual percentage rate" and represents the cost of borrowing.

For example, a credit card with a 22% APR charges interest on any outstanding balance at an annual rate of 22%. If you carry a balance from month to month, you'll accrue interest at this rate, making unpaid balances more expensive. To avoid interest charges, it's best to pay off your balance in full each month.

Some cards offer special introductory rates, like 0% APR for a certain period. During this time, you won't pay interest. 

Benefits of using a credit card

Credit cards offer several advantages:

Spreading payments: For large purchases, you can spread the cost over several repayment periods. This can help you manage your budget and expenses. 

Purchase protection: Many credit cards protect purchases between £100 and £30,000 under Section 75 of the Consumer Credit Act, helping you get your money back if something goes wrong.

Cashback and rewards: Earn cashback, air miles, or loyalty points with many credit card providers, helping you save money.

Boost your credit score: Staying within your credit limit and paying off your full balance each month can improve your credit score. However, missing or making late payments and going over your limit can hurt it.

Disadvantages of using a credit card

While credit cards offer many benefits, there are also some potential drawbacks to be aware of:

High-interest payments: Credit cards often have higher interest rates than other forms of borrowing. If you don't pay off your balance in full each month, your debt can quickly become unmanageable.

Fees: Credit cards come with various fees, including:

Annual fees: Some cards charge a yearly fee just for having the card.

Late payment fees: Missing a payment deadline can result in a fee and negatively impact your credit score.

Foreign transaction fees: Using your card abroad may incur a 2-3% fee on each transaction.

Returned payment fees: If a payment bounces due to insufficient funds, you might be charged a fee.

Cash advance fees: Withdrawing from a cash machine with your credit card often incurs a fee.

Paying more for your purchases: If you don’t pay off your full balance each month, you’ll accrue interest, which means you'll end up paying more for your purchases over time.

Debt: One of the biggest drawbacks of credit cards is the risk of accumulating debt. If you can't pay back what you owe, your debt can quickly grow faster than you can manage.

Is a credit card right for me?

A credit card might be a good fit if you can consistently make your repayments and pay off your full balance each month. This not only helps you avoid high-interest charges but also boosts your credit score. However, be careful not to max out your credit limit, as this can negatively impact your credit.

On the other hand, if you struggle to keep up with repayments or are already in debt, a credit card may not be the best option and could worsen your financial situation. 

Be mindful to consider your circumstances carefully and compare all your borrowing options before applying for a credit card.