Understanding Credit Cards


July 2015

Understanding Credit Cards

Credit Cards - How do they work?

Many people are daunted by the idea of getting a credit card, with many believing them to be risky and complicated. There are a great deal of terms and conditions to take into consideration which often put people off credit cards.

There are also people who rush too hastily into taking out a credit card. People who don't fully understand what they are getting into or how to deal with the commitment that they are making.

Once you understand exactly what having a credit card entails, it is easy to make sure that you can cope with the responsibility of owning one. Used correctly, credit cards can actually help you to improve your financial situation.

Credit cards - what are they?

A credit card looks a lot like a debit card and works in a very similar way. It is made of plastic and works via a magnetic strip and an electronic microchip. This strip and chip are used to communicate directly with your bank and transmit your transaction information in a secure manner. Like debit cards you will be given a personal identity number to enter when you are making a new purchase, many credit cards are now being offered with contactless payments as well.

Credit cards are different from debit cards because of the way in which your payments are made. With a debit card, money is taken directly from your account when you make a purchase. With a credit card, the payments that you make are lent to you by the bank as an advance. They serve as an unsecured loan that you can take out at any point and pay back at a later date. Each card comes with a credit limit that represents the most that you can borrow. They also come with a minimum repayment that you must make back every month.

How much do credit cards cost?

The main cost of credit cards is the interest that you are charged for the money that you borrow. If you were to borrow £1,000 on your credit card and the interest that you are charged is 10%, the loan will have cost you £100.

One thing to bear in mind however is the fact that this interest is worked out over the course of a year. It is for this reason that it is referred to as APR (Annualised Percentage Rate). This means that you only have to pay £100 if it takes you an entire 12 months to pay it back.

If you are paying back on a monthly basis, then it will only cost you one twelfth of the APR. This means that if you were to borrow £1000 and pay it off in a month, you would only be charged 0.83% interest. This would translate to a cost of £8.30 if you pay back the £1000 in full in that month.

What should you buy on a credit card?

Put simply a credit card is supposed to be used to pay for things in advance when you don't have the money readily available. For this reason many people use their credit cards to make purchases that fall before their payday.

You should also be advised that your credit card is not meant to be used to take out cash from ATMs. If you do this you may be subject to a rather large charge from your credit card company.

Generally speaking people use their credit card to make large purchases which would otherwise require an inconveniently large outlay. These types of purchases include furniture, flights or holiday bookings and large supermarket shops.

Another reason that people use credit cards for these kinds of deals is because doing so will give you payment protection on the purchase. There are many different types of credit cards available on the market and each one is designed to serve a slightly different purpose, it is important that you choose the credit card to suit your needs.

How to get a credit card

To be eligible for a credit card you must be over 18 and live in the UK. You must also be on a certain yearly income, typically over £10,000. Individual credit card companies will have their own application criteria and you will therefore need to check if you have a specific credit card in mind.

Check Your Credit Rating

Before you apply for a credit card you should first try and establish what your credit score is. This is probably the most important factor that any lender will consider before allowing you to take out a loan or a credit card. It is important to find this out first because if you end up getting rejected for the card, it will negatively impact your credit score.

Compare Credit Cards

There are a lot of different types of credit card out there so it is important that you look into them properly before you decide upon one. Some of them offer better interest rates, lower fees, better cashback options and so on.

Make an Application

Once you've decided upon which credit card you would like to opt for, it's time to actually apply for a card. You can either get yourself a paper application from your bank or you can do it via an online form. Normally you will find out straight away if you have been accepted by the bank but this can take slightly longer.

Budget for your monthly repayments

One thing that is absolutely vital is that you make sure that you can afford to meet your repayments. Normally you only have to pay back a minimum of £5 a month or a set percentage of your debt, however certain cards require you to pay back your debt in full each month. Failing to make repayments can mean that you are charged late fees or could see your credit rating affected.