Credit cards are a convenient way to pay for a whole range of purchases, from a handbag to a holiday. But remember that credit cards are not the same as debit cards. When you take out a credit card, you are effectively borrowing money. And if you use the card unwisely, you could build up a very expensive debt.
How do credit cards work?
You can use your credit card to pay for things in a shop or online – and in most countries around the world. The card issuer will send you a bill every month with a list of all your transactions. If you pay the bill off in full, there is usually no interest to pay, so the card works like an interest-free loan. But if you cannot afford to clear the debt each month, you could start to pay interest at a rate of about 18%. In other words, credit cards can be expensive and are not a solution to a long-term debt problem.
Watch out for hidden costs
Most credit cards charge penalty fees for late or missed payments. You will also be charged if you spend more than the agreed limit.
But some costs are not so explicit. If you pay off only the minimum payment each month, it could take years to clear your debt and cost hundreds or even thousands of pounds in interest.
You should also watch out for charges at the ATM. Most credit card firms charge a fee of about 2% for cash withdrawals. There is usually no interest-free period, either. So you start to incur interest immediately.
Which card is best for me?
There are literally hundreds of credit card deals on the market, but they fall broadly into six categories. The best card for you depends on a number of factors, including whether or not you will pay off the balance each month, and how you intend to use the card.
Most people check out the interest rate on a credit card, but if you clear your balance in full each month, the interest rate is not important. Instead, you would be better off with a card that offers some kind of reward when you spend. Cashback cards are popular because they pay you to shop. For example, you might earn 1% cashback every time you spend on the card. But you can also accrue loyalty points or Avios air miles with a reward credit card.
Borrow money for free
If you want to spend on your card, perhaps to buy a big ticket item such as a washing machine, you might not be able to afford to pay off the debt in full at the end of the month. A 0% deal on purchases could therefore be a wise choice. There are a number of credit cards available with introductory purchase offers – it’s possible to benefit from an interest free period that last for more than two years.
As long as you pay off the outstanding amount before the 0% deal expires, the loan is free. It’s a good idea to set up a direct debit to make sure you clear the balance on time. Otherwise you could be in for a shock at the end of the 0% period as the rate of interest will probably leap to around 18%.
Switch your balance
If you already owe money on a credit or store card, a 0% balance transfer card is what you need. You can then move your debt onto the new card and pay no interest for a certain length of time - possibly three years or more. You will normally have to pay a balance transfer fee of about 3% of the debt, but the amount you save in interest can more than cover the cost.
Some cards have interest-free periods on both purchases and balance transfers. But you can usually benefit from longer 0% periods if you take out two separate cards.
Low lifetime rates
Some people are happy to switch from one 0% deal to another. Others prefer the simplicity of a card that charges a low rate for as long as it takes to clear the debt. There are no 0% offers, but no bill shocks either.
Boost your credit score
Card issuers these days are fussy about their customers. They want people with a perfect or near perfect credit score, so if you have struggled with debts in the past your application could be refused.
That doesn’t mean the door is shut if you have a chequered credit history. There are cards available if you have a poor credit score. The cards charge a high rate of interest, but they can help you to improve your credit rating. If you manage your payments carefully, you can therefore boost your score and hopefully qualify for a mainstream card.
This type of card can also be useful if you have never previously borrowed money, so have not had an opportunity to build up a credit history.
Most people take a credit card on holiday because it’s a convenient way to carry money – and can be particularly useful in an emergency
There are other options too though. Some prepaid cards (which require you to load up cash on them in advance and therefore don’t require a credit check), come with a facility called Creditbuilder.
This works by the card provider effectively ‘lending’ you a full year’s worth of the monthly card fees upfront. While you won’t have to pay interest on this ‘loan’ you will be required to pay it back over a period of 12 months. Details of how well you manage your repayments will then be passed to the credit reference agencies. And, providing you have been reliable, this will help serve in upping your credit score. So you can help yourself, without putting yourself at risk of getting into debt or forking out expensive interest charged by credit builder credit cards.
Most people take a credit card on holiday because it’s a convenient way to carry money – and can be particularly useful in an emergency. But most card issuers charge a foreign usage fee when you use your card abroad, so it can work out expensive. Frequent travellers should therefore look for cards with either no or low foreign usage fees.
Who pays the advertised rate?
Most credit card firms operate a system known as risk based pricing. In other words, if you are a high risk customer you might not be offered the advertised low rate. There are strict rules that govern advertised rates, but card companies need only offer the advertised or typical rate to 51% of customers. In other words, almost half could be charged a higher rate.
Avoid the debt trap
If you feel you are sinking into a debt trap, you should get help straightaway. There are a number of organisations that offer free debt counselling, including Citizens Advice Bureau (www.citizensadvice.org.uk), Consumer Credit Counselling Service (www.cccs.co.uk) and National Debtline (www.nationaldebtline.co.uk).
Compare credit cards
MoneySuperMarket’s free independent comparison service is a quick and easy way to compare hundreds of credit card deals online. It doesn’t matter whether you want to spend on the card, switch a balance or earn a reward. MoneySuperMarket can find the best card for you at the click of a mouse. To find out which cards you'd be accepted for without affecting your credit score, try our quick and easy card search.
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