The guide to credit cards. Overcome those plastic worries.

By Philippa Guy
1

What are credit cards and how can you avoid the common pitfalls? Here's the do's & don'ts.

We’ve all heard the horror stories, months of overspending and getting into debt, resulting in plastic cards being cut up into small pieces in a desperate attempt to stop spending. Yet other people use them sensibly and banks recommend them as a safe way to buy goods and protect against fraud.

The differences between debit and credit cards

Debit and credit cards may look the same – small rectangles of plastic with a magnetic strip on the back – but they act in fundamentally different ways. When you use a debit card, money is taken directly from your current account to pay for an item. You need to have enough money in your account or an overdraft to complete the transaction. A credit card, however, is not linked to your current account but works by using the card issuer’s money (generally a bank). It is essentially a loan: you borrow a certain amount and agree to pay it back later. No money actually leaves your current account; the card issuer pays and you have an interest-free period before it needs to be paid back. Spend now and pay later sums up the credit card’s remit.

How does a credit card actually work?

Firstly, you have to apply for a credit card. The bank or lender will run checks on your financial history, so if you have a history of repeatedly failing to pay off your debt on time, unauthorised overdrafts or no income, your application might be refused. Be careful to read all the conditions and speak to your bank beforehand, as a refusal doesn’t look good on your credit history.

Secondly, every credit card has a credit limit. This means that you can’t spend as much as you like on a new car or a blowout holiday in the Seychelles. When you get a credit card, the credit card provider will set a credit limit, which means that there is a maximum limit on what you can spend. Make sure you stay under this amount every month as the bank will charge you if you exceed it. Being smart with your credit card is important, here are a few things that are handy to know before applying!

Thirdly, every month you will receive a statement from your credit card provider telling you how much you owe. You will then have three choices and it is here that credit cards can lead you into murky waters! The first and only recommended option is to pay off the whole balance on your credit card every month. This is the way to prevent spiralling into debt that could take months to pay off. The best method is to set up a direct debit from your current account so that you won’t miss a payment (which will result in a late payment fee). Wondering whether to take out a credit card? Click here to read more about credit cards can help improve your credit history and even make a little extra cash!

Dangers of credit cards

If you choose not to pay the whole balance each month, you must pay the minimum balance to avoid the late payment fee. However, it’s at this point that the bank will start to charge you interest on your outstanding balance.

Interest simply means the amount you are charged by a lender for borrowing money - click here to know more. As mentioned, credit cards offer an interest-free period, so if you clear your whole balance every month, you will never pay any interest. However, as soon as this period is over, your credit card provider will start to charge you. The APR (annual percentage rate) is the yearly amount it will cost you to borrow money, on top of what you spend. If you have an outstanding balance of £1000 and the APR is 15%, you will be charged an extra £150. APRs differ between credit cards so it’s definitely worth considering a card with a low APR, although this rate might not last for the lifetime of your card. Unfortunately interest accrues over time – the longer you take to pay off your balance, the more you will be charged. So what was initially a £50 purchase will suddenly cost you £60, then £70, then £100 as you will pay interest on your interest! (This is called compound interest and may evoke memories of GCSE mathematics.) And what was initially a convenient way of borrowing money interest-free starts to become a one-way road to debt and stress. Credit card debt can feel overwhelming at times so here's an article on our top tips for paying it off.

Try to pay as much off as you can

The final option is to pay off as much of the balance as you can. Although this is better than simply paying off the minimum balance, you will still be charged interest on any outstanding debt. If you are paying a high rate of interest, you do have another option to save money. It is possible to transfer your balance to a new card lender who offers a lower or occasionally 0% interest rate for a set period. For example, you can find lenders that offer 0% interest for over three years if you transfer your balance. However, if you don’t clear your debt within this period, you will start paying interest again (probably at a high rate!). Furthermore, you will have to pay a transfer fee, which can be up to 4%. Therefore transferring £1000 would cost you £40 in fees. However, a lower rate of interest could save money in the long-term, so it’s worth doing some calculations. As usual, acceptance for these deals might depend on your credit history and financial circumstances. If you're thinking of consolidating your debts, this article may help you. 

To summarise, credit cards initially offer you the option to borrow money for free (unless you are transferring your existing balance to a new card), but the lenders will quickly start to charge you extra if you fail to repay this amount in full every month.  

A final point of warning: credit cards also charge if you use them at an ATM to withdraw cash. If you want to withdraw £10, you could be charged a £3 fee and you will have to pay interest immediately on the cash that you take out.

Are there any benefits to credit cards?

Yes! As well as being able to buy an item now and pay for it later, there are other advantages to credit cards. Unlike debit cards, credit cards offer protection for purchases between £100 and £30,000. If your purchase is faulty or if a company goes bust, you can claim the money back from your credit card issuer. Some credit card companies even offer an extra year’s warranty on products bought with their cards. Furthermore, if you are a victim of fraud, your credit card company will also refund any money stolen from you (unless you have left your PIN number lying around which would be negligent!). Credit cards can offer rewards and benefits, such as air miles or special offers for students, so it’s worth doing some research to find the best option for you. If you want to compare and check out which credit cards are best for you, go on over to our compare site.

Top Takeaway

DOs

DO pay off the whole balance on your credit card every month

DO set up a direct debit so you don’t forget to make the monthly payment

DO keep a close eye on how much you are spending – check online regularly

 

DON’Ts

DON’T use a credit card if you have a history of overspending and debt

DON’T spend more than you can pay back each month

DON’T use a credit card to take out cash from an ATM

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