What is a credit card?

Credit cards: what are they and how do they work?

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A credit card is a type of loan, where the money you spend is actually borrowed from the card provider rather than debited from your personal account.

Person using a credit card

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What is a credit card?

A credit card is a plastic card that gives you access to credit you can spend to make purchases, reduce debt, and earn rewards. A credit card may be issued by a bank, building society, or other type of credit lender.

How do credit cards work?

Credit cards essentially work as a loan, but instead of getting money in your bank account you get credit on your credit card. Your lender will set you a credit limit, and you’ll be able to spend as much of it as you need before paying back some or all of your balance each month.

What types of credit card can I get?

You can get the following types of credit card, depending on your needs:

  • Balance transfer cards: balance transfer credit cards let you move an existing debt over to a new credit card, often with lower interest rates. This means you can pay off your balance built up on other credit cards with a cheaper rate of interest
  • Credit builder cards: credit builder credit cards give you the opportunity to build up your credit report if you have a poor or limited borrowing history. They often have high interest rates, but if you use them sensibly and repay everything you owe each month, they can help you demonstrate you are a responsible borrower
  • Rewards cards: a rewards credit card gives you access to benefits and incentives, such as store points, airmiles, or cashback on purchases, every time you use the card. However they can also come with a fee, and if you miss too many repayment you could lose access to these benefits
  • Overseas cards: having an overseas credit card means you’ll be able to use it abroad without incurring a fee. They can be a useful way to manage your holiday spending, as you won’t have to worry about running out of cash or carrying it around with you
  • Money transfer cards: a money transfer credit card is similar to a balance transfer card, but instead of moving an existing balance to pay off at a lower rate, you move money from your credit card into a bank account. They can be useful for paying off a loan or overdraft
  • Purchase cards: purchase credit cards are designed to be used for shopping, and many of them offer low or 0% interest rates when you use them for purchases. This essentially means you can borrow money for free

How should I use my credit card?

There are some general rules you should follow when using your credit card, as they can help you build a strong credit report. For example:

1.       Keep your credit utilisation ratio low:

Your credit utilisation ratio is the amount of credit you’ve used in relation to what you have available. For example, if your credit limit is £1,000, and you’ve used £500, your credit utilisation ratio would be 50%.

However most lenders would prefer you to keep your ratio under 30%, as using up more of your limit can indicate you are financially stretched and therefore a higher risk borrower.

2.       Make your repayments on time

While most credit cards charge a fee if you miss your monthly repayments, it can also mean you lose any benefits or incentives attached to your credit card, such as low or zero interest periods or cashback.

As well as that, missing too many payments can harm your credit report – this means it will be harder to be accepted for loans and credit in the future.

3.       Pay more than just the minimum

When you make your credit card payments each month, there is usually a set minimum amount you can pay to avoid late fees and losing your incentives. This can be useful for months where your budget is tight. But aiming for just the minimum over a stretch of time generally means it’ll take longer to pay your balance off.

You’ll also end up paying much more in interest, making it an expensive way of repaying the loan. Read our guide to minimum credit card payments to learn more.

4.       Set up a direct debit

If you think you might forget to pay off your balance each month, it can be useful to set up a direct debit to pay off at least the minimum amount. This way you can rest easy knowing you’ve met the minimum, while there’s nothing stopping you from paying even more on top when you can.

5.       Don’t withdraw cash or use it abroad

Unless it’s stated specifically on your credit agreement, you’ll likely be charged a fee if you want to use your credit card to withdraw cash or to spend overseas. It’s best to check beforehand to make sure you know how you’ll be able to use the card.

6.       Take advantage of rewards

Some credit cards come with rewards like cashback on purchases or airmiles every time you spend, though lenders often charge a fee for these cards. If you think these rewards will be useful then it may be worth the cost. But if you’re not likely to take advantage of them then you should consider whether you need the incentives.

How do I apply for a credit card?

When you apply for a credit card, using MoneySuperMarket’s eligibility checker can be a good way to make sure you find a credit card you’re likely to be accepted for.

When you’ve found the one you want, you can generally apply by phone, by post, or in the lender’s branch if they have one – however in most cases it will be easier to apply online.

If your application is accepted, your lender will set you a credit limit and give you your interest rate – keep in mind this may be different to the APR advertised. This is because the advertised APR only has to be offered to 51% of successful applicants – the actual rate you get will depend on factors such as your credit history and personal financial circumstances.

You’ll be send your new credit card in the post, and once you have it you just need to activate the card and it’ll be ready to use.

Should I apply for a credit card?

Before you apply for a credit card, you should consider the following:

  • Your existing debt: if you have any existing debt, you might want to pay as much of that off as you can before applying. This is because existing debt can indicate stretched finances to lenders, who might be put off lending to you as you will appear to be a high risk applicant
  • Your open accounts: if you have any open unused credit accounts it can be a good idea to close these, as otherwise lenders may think you will struggle to settle all of your outstanding balances
  • Your application: before you submit your application you should make sure all the details are correctly filled out, as even a small mistake can lead to your application being refused. If you are turned down for credit it’s best to wait some time before applying again. This is because making too many applications in a short space of time can make you look like a high risk borrower
  • Your credit history: your credit history is arguably the most important factor lenders consider. It gives them an idea of how trustworthy you are with credit and how likely you are to make your repayments on time and in full

What is a credit score?

Your credit score is a number assigned to you by your lender when you apply to take out credit or a loan. Your lender calculates your credit score by looking at your credit history and report, which they can get from their own personal records as well as from one of three credit reference agencies in the UK.

This means you don’t have a single credit score, as lenders will have their own acceptance criteria to consider when they calculate your score – so you could have different scores with different lenders.

Read more about how lenders and credit reference agencies work with our guide to your credit score.

How much does it cost to use a credit card?

The cost of using a credit card will depend on the card you take out as well as how you use it. You can break down the potential costs into the following:

Interest rate

The interest rate of a credit card tells you how much it’ll cost to borrow money from your lender – essentially, how much you’ll pay back on top of the actual amount you borrowed.

Some credit cards offer zero interest on purchases, balance transfers, and money transfers, however you can also avoid paying interest on your credit card if you repay your entire balance every month.

Fees and charges

In addition to interest, there are likely to be fees and charges involved in your credit agreement. These can include late/missed payment charges, charges for exceeding your credit limit, withdrawal fees, and fees for using the card overseas.

There may also be charges for any benefits or incentives you get as part of the credit card deal.

How much can I spend on a credit card?

The amount you’ll be able to spend using your credit card will depend on the credit limit you’re given by your lender.

They’ll normally decide on your credit limit after running a credit check, where they consider your outstanding debts, any missed payments, and the amount of credit you currently have available.

It’s possible to increase your credit limit if you ask your provider, and they’ll use the same information to judge whether they’ll change your limit for you.

Keep in mind that if you go over your credit limit this will normally bring a fee.

Am I protected when I spend using a credit card?

Any purchases you make between £100 and £30,000 are protected by the Consumer Credit Agreement, which holds the credit card provider equally liable if anything goes wrong with your purchase.

For example, this could include if the supplier of the goods or services go bust or if your goods aren’t delivered. Read more about how this works with our guide to credit card protection.

Compare credit cards

Comparing credit cards on MoneySuperMarket can help you find the right card for your needs. All you need to do is tell us a little about yourself, your financial situation, and what you plan to use the card for – then we can show you a list of deals tailored to you.

You’ll be able to compare them by their interest rates, benefits, fees and charges, and how likely you are to be accepted if you apply for the card. This way you can apply only when you’re sure you’ll get the card you want, minimising the number of applications you might have to make and therefore protecting your credit score.

Once you’ve found your ideal credit card, just click through to the provider to finalise your application. If it’s accepted, they’ll set your credit limit and interest rate – remember the interest rate advertised on the deal only has to be offered to 51% of successful applicants.

The actual rate you’re offered may be different, as your lender will use your credit and borrowing history to determine yours.

Once you get the card through the post, all you need to do is activate it and it’ll be ready to use.

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