A Three Step Guide To Credit Cards

Credit cards offer a convenient way of borrowing and when used properly they can provide flexibility and a range of useful benefits for the cardholder. Our three step guide to credit cards shows you how to choose the right product for you and how to avoid any nasty surprises.

Step 1 - Choosing the right card(s)

To get the most out of your credit card it is important to decide whether it's actually suited to the purpose for which you intend to use it.

What do I need the card for?

Many people use credit cards that don't fit with their spending or repayment habits. As a result they end up paying more than they need for the privilege. Any credit card is useful, but it can be even better if you have the best card for your circumstances. Identifying the most suitable product for your needs may reduce the interest you pay or increase the loyalty benefits you receive.

There is more choice than ever because credit card providers are competing harder for your business, so it is important to choose the right deal for you and take advantage of the options available.

Some of the many benefits of using a credit card are:

• Free, short-term credit as long as you always pay your balance in full by the due date shown on your statement.
• A safe and convenient way to pay for goods and services both in the UK and abroad, particularly if you are purchasing over the internet, phone or by mail order.
• Liability for purchased goods - under Section 75 of the 1974 Consumer Credit Act card issuers and retailers take joint responsibility for faulty purchases. If you pay for something with a credit card, valued between £100 and £30,000, that turns out to be faulty or which you do not receive because the company goes bust, you can claim a refund from the card provider. However, credit card cheques are not covered because they can be made payable to anyone – not just to the suppliers appointed to accept the credit card. And the credit card company would not share liability if the card was used to withdraw cash to pay for the purchase.
• Protection against fraud — if you are the innocent victim of fraud you will not be expected to pay if a criminal uses your card, however it is important that you report your suspicions as soon as possible.
• Incentives for using a card such as loyalty points and cash back, or payments to support a charity.
• A truly global currency, as credit cards are accepted in virtually every country around the world.

When weighing up your reasons for applying for a credit card, make sure you read the small print, otherwise you could be caught out by hidden fees and charges.

There are basically three ways of using a credit card: straightforward purchases, moving an outstanding debt over from another card (known as a balance transfer), and withdrawing money from a cash machine. Providers tend to charge a different rate of interest for each, and then implement a payment hierarchy whereby the cheapest debt is cleared first, leaving you accruing interest at the highest rate.

Say you took out a new credit card and transferred £1,000 over from another card, made a £500 purchase and withdrew £200 from an ATM. You can't afford to clear the £1,700 in full at the end of the month, so instead you plan to repay £150 each month. However, rather than being charged interest at one rate, you are charged 5% for the transferred balance, 16% for the purchase and 25% on the cash withdrawal. The chances are, the provider will use the £150 you pay off each month, to clear the balance transfer first – the last debt to be repaid will be the £200 you withdrew from the cash machine, and that is the balance you are charged the highest rate of interest on.

Annual fees are still unusual, so the best way to avoid such tactics is to use a different credit card for each different purpose, that way you'll get the most out of your credit card for the minimum cost. (One tip though, is never use a credit card for withdrawing cash – not only are the interest rates for cash withdrawals usually significantly higher than those for purchases and balance transfers but you also get no interest free period. Interest is levied from the day you make the withdrawal, so even if you pay off your balance in full at the end of the month, you will not be able to escape it.)

Comparing credit cards has become easier. Providers are now obliged to summarise their key product features such as interest charges and fees in an easy-to-understand format, known as a summary or "honesty" box. This will appear in all credit card marketing information.

Even so, with hundreds of deals available, working your way through the credit card maze can still be a daunting prospect. Our guide to spending and repayment habits may help you to identify the best card for your needs.

Regular spender – your balance is always cleared in full each month

If you often use your card for purchases but clear the balance in full each month, you can avoid paying interest.

Most cards offer an interest-free period of up to 59 days from the date of the transaction, which gives you some breathing space before your payment is due. However, there are a few deals that do not offer any grace period even if you clear your debt in full each month, so watch out for these.

If you always pay off your credit card, the interest rate is irrelevant. Instead look for a deal that will reward you for spending. A number of cards offer reward schemes either in the form of cashback, charitable donations or loyalty points. Some are more generous than others so go for the card that gives you the best return on your spend.

If you can afford to clear you balance in full each month, but have a tendency to forget, or be late, making your payment, then set up a direct debit. This is the easiest way to guarantee you'll always pay off your debt on time and avoid a penalty charge.

Click to compare:

• Cashback Credit Cards
• Reward Credit Cards

Regular spender - your balance is usually cleared in full each month

So you like spending on your card and you're pretty good at clearing your balance each month but just occasionally you choose to carry a balance forward. With this scenario, it makes sense to choose a card that offers a low standard rate of interest.

Click to compare:

• Standard Interest Rate Cards
• Cashback credit cards
• Reward credit cards

Regular spender - your balance is rarely or never cleared in full each month

If you use your credit card but can't afford to pay it off in full each month, your best bet is a card with an introductory purchase offer or a low standard rate.

There are a number of deals which have interest free introductory periods. These can be great for those who don't clear their balance each month. However, once the interest free period ends, you will be charged the standard rate of interest which will probably be between 12 per cent and 20 per cent. You therefore need to make sure you have paid your debt off by that time, or make a balance transfer and move it to another card.

Some people don't want the hassle of having to shop around for a new credit card every six to 12 months in which case a card with a low standard rate of interest is worth considering.

If you've built up a debt on an existing card then look to move it over to a product offering a low balance transfer rate. Plenty of cards offer 'double deals' - a low introductory rate for purchases as well as a competitive balance transfer rate (often 0% for both). These can be great if you want a card for spending as well. However, the 0% introductory periods can end at different times, so it may be worth opting for two separate cards – one for your balance transfer and one for your purchases – to avoid being caught by the payment hierarchy tactic mentioned above (where the cheapest debt is cleared first).

Click to compare:

• Credit cards with introductory purchase rate and balance transfer rate
• All balance transfer cards
• Introductory purchase rate cards

Exasperated borrower – you have an existing debt that you are determined to clear

It is very easy to run up a debt on a credit card but paying it off can be much harder. UK card holders owed an average of £2,060 each in 2007, according to Apacs, the clearing service. Re-paying this amount of money can take years unless you are disciplined.

The first thing to do is make sure you pay off more than the minimum each month. Card providers insist you make a repayment every month but the amount you have to pay tend to be very low – often around 2% of the outstanding balance or £5, whichever is greater. If this is all you pay each month it could take years to clear your debt as you'll be repaying little more than the monthly interest charges. In order to clear your debt as quickly as possible, you therefore need to work out the maximum you can afford to repay each month.

For example, if you owed £2,000 on a card with an interest rate of 15.9%, it would take you 29 years and 4 months to clear your debt if you only repaid a minimum of 2%, (with a £5 minimum). However, if you increased your monthly payment to £100, you would be debt free after 2 years.

The other important thing to do is minimise the interest you pay. There are plenty of credit card deals offering interest free periods on balance transfers, so take advantage of one of these. You will have to pay a transfer fee of 2% to 3%, which will be added to your balance, but this is worth paying if you can avoid being charged a high rate of interest.

The best balance transfer offers last for at least 12 months. If possible aim to have your debt cleared within that time. If you cannot do that, make a note of when the introductory offer expires - you can then move your balance over to another 0% deal and continue to avoid interest charges.

If you think you'll be slow to switch when the introductory period expires or don't want the hassle of continually churning your debt, then a card with a low lifetime balance transfer rate could be your best bet.

Whichever card you choose remember that any new spend will incur interest at the standard rate and, in the majority of cases, will be cleared after any debt charged at the promotional rate. Click here to see how much you can save or here to compare all balance transfer rates, including 0% deals.

It is also important to compare the cost of the balance transfer fee as this can make a big difference to the cost of repaying your debt.

High credit risk - how to get a card if you have a poor credit history

It can be difficult to get a credit card if you have no previous credit history, have changed addresses frequently or are self-employed. Anyone who has defaulted on loan or card repayments, or who has county court judgements (CCJs) against them may also struggle to get credit.

There are card issuers that can help in these circumstances, but be warned, you are unlikely to be offered the most competitive rate of interest. However, this type of card can still be worth taking because if you use it responsibly, it can help build or rebuild your credit rating. Click here to compare 'low credit score' credit cards.

Overseas traveller - Do you know how much it is costing you to use your card abroad?

Credit cards can be a safe and convenient method of payment, particularly when you are abroad, but they can also be costly. Most providers levy overseas usage fees which can significantly bump up the costs of a foreign transaction. British consumers spend about £300m a year on foreign usage fees according to Nationwide building society.

Credit card exchange rates are based on the Visa and Mastercard wholesale rates, with a loading percentage usually added by the card issuers. This can vary from 0% to 3% depending on the credit card. The rate applied may also be different depending on where in the world you are – some providers levy higher charges in countries outside Europe.

When selecting a credit card for use abroad it is also worth looking at the other facilities on offer, such as the provision of a replacement card in the event of the loss or theft of your own. Extra benefits may include an international assistance package or insurance for flight delays, lost luggage and personal injury.

To make choosing a UK credit card for use abroad a little easier we have dedicated a comparison table to the cause.

Another option if you are a regular traveller, is to go for a prepaid card, This type of card is relatively new to the market but an increasing number of providers are offering them. They can be used in the same way as a credit or debit card, but the difference is that you have to load money onto them beforehand and they do not offer a credit facility – you can only spend what is on there.

The fees on prepaid cards can be significantly lower than those charged by many credit card providers so they may provide a more cost effective alternative.

Click here to compare travel money cards

Risks of holding credit cards

• Without careful management and willpower, they can lead to unplanned levels of debt – think before you buy.
• Watch out for penalty fees - if you are late making your monthly payment, miss it altogether or go over your credit limit you will incur a charge of about £12. If you are part way through an introductory period, you may also find the promotional interest rate is cancelled. Paying by direct debit is simple way to ensure this doesn't happen.
• Making late payments on a regular basis can seriously damage your credit rating.
• If you only make the minimum repayment, it could take you years to repay your debt and cost you thousands of pounds extra in interest.
• If you have outstanding balances on a number of cards, consider consolidating them onto one. This will make it easier to manage your finances.
• Cancel any cards you no longer use as they may inhibit your ability to get further credit in the future. Firms are increasingly looking at the total credit available to you, rather than just focusing on your outstanding debt.

Step 2 - How do I apply?

You can apply for a credit card without leaving this site. If you haven't already used any of the links to go direct to a card comparison table then click the button below to find the card that best suits your circumstances.

It is important only to make applications that are likely to be accepted. Every time you apply for credit, a 'footprint' appears on your credit file. If you have an application declined it can have a negative impact on your credit score.

Step 3 - What if things go wrong?

If you are unable to meet your monthly repayments and are struggling to repay your outstanding balance, contact your credit card issuer. The earlier you approach them, the more sympathetic they will be to your situation.

Alternatively, consider switching your card to one with lower rates and fees before you become too bogged down with your repayments but beware - if you leave it too long you may struggle to find another company that is willing to lend to you.

If you are refused a credit card and wish to make enquiries concerning your own credit file you can apply to the credit reference agency for your record. This will show your past repayment history, any CCJs or defaults registered against you, electoral roll details and previous credit searches.

Further Advice

Free advice is available from your local Citizen's Advice Bureau, the National Debtline on 0808 808 4000 or the Consumer Credit Counselling Service (CCCS) on 0800 138 1111.

Further information:

A history of plastic cards in the UK

How the payment card transaction process works

This was last updated in February 2008.