How do credit cards work? - A complete guide
The subject of credit cards is often one that many people avoid broaching as they’re not quite fully understanding of what it means to have a credit card and how it can actually be beneficial to have one in some instances.
In our ultimate guide to credit cards explained, we’ll take you through everything you need to know about how credit cards work, the benefits of having and using a credit card, the best way to use it, plus all the different types of credit cards you can get in the UK.
How do credit cards work?
In the most simple terms, credit cards enable you to purchase items or services and then pay for them later. They can be thought of as almost like a loan, in that you get to use and benefit from the good or service that you purchased, but you don’t actually have to pay for it right away.
In essence, when you buy something, your credit card company will pay for it and then send you your credit card bill at the end of the month, which you then have to pay off.
If you pay the full amount of your credit card bill right away, you likely won’t have to pay any interest.
How does credit card interest work?
While paying off your credit card bill straight away when you receive it each month will result in you not having to pay any interest, if you only pay a small amount of your bill, for example just half of it, then it will be carried over into the following month and you will be charged interest as a percentage until you’re able to pay back the full amount.
This means that you’ll actually end up paying back more than you “borrowed” due to the interest accumulating over the period of time that you take to pay the money back.
Types of credit cards
There are various types of credit cards, all serving different needs and purposes. For example, if you were to make a credit card payment to book things like holidays and hotels, you would want to have a specific travel credit card.
Take a look at some of the most common types of credit cards below.
Interest-free credit card
An interest free credit card does exactly what it says; it offers you 0% interest on your spending .
This is often seen as the cheapest type of borrowing as you’ll be able to spend money on the card without having to pay extra interest on top of the repayments.
Credit builder credit card
If you don’t yet have a credit score, or if you have a poor score, credit builder cards can be used to help build it back up, providing that you pay off the balance in full every month.
Purchase credit cards
This type of credit card allows you to purchase goods upfront and then pay them off in monthly instalments, often at 0% interest for a few months.
Reward credit cards
Reward credit cards offer you cash incentives or loyalty points when you spend normally on them and always ensure that you pay back the money in full every month.
Balance transfer card
This type of credit card essentially repays the debt on other credit or store cards for you at 0%, which means you will hopefully be able to get rid of your debt quicker as it pays the actual debt rather than going towards the interest.
Travel credit card
If you’re a frequent traveller then a travel-specific credit card could benefit you. It allows you to pay for things abroad without having to pay a transaction fee on top, like you would with many other types of credit cards.
Why get a credit card?
You might want to get a credit card for several different reasons - for example, if you need a little bit of extra money to pay for things if money is a little bit tight.
You might also want to get one in order to help improve your credit score so that you can increase your chances of being accepted for other types of borrowing such as getting a mortgage.
Whatever your reason for getting a credit card, it’s imperative that you’re aware of the pros and cons of doing so.
Advantages of a credit card
While of course there are certain disadvantages of having a credit card such as potentially accumulating more debt and being unable to make the repayments, there are also several credit card benefits that you can enjoy too.
- Credit card protection - this is when you get extra protection on purchases anywhere between £100 and £30,000. It means that your credit card provider will be jointly responsible for refunding you the entire amount of your purchase if anything goes wrong (such as damaged, lost or faulty goods).
- Help to improve credit score - another advantage of a credit card is that it can help to boost your credit rating, as long as you stay within your credit limit and ensure that you pay back at least the minimum amount every month, then it will provide evidence that you can stick to a financial agreement and make your repayments on time.
- Can often benefit from rewards or 0% interest rates - some types of credit cards offer incentives such as 0% interest rates when you first sign up, or longer reward-based incentives such as cashback.
You might like: A guide to credit card protection
Do I need a credit card?
Determining whether or not you need a credit card depends on whether you think you would benefit from having one, or if it would just mean that you’d rack up more debt.
You need to think carefully about whether you’ll be able to make the repayments if you take out a credit card and what it will mean if you can’t pay the money back and whether you can afford the added interest.
You also need to think about what you actually want to use your credit card for, in order to help determine which one is best suited to you.
For more information and advice regarding credit cards and borrowing, take a look at our useful guides below.