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A simple guide to credit cards

Used well, a credit card is a secure and flexible way to pay and can be a good way to spread the cost of major purchases. But if you only make minimum payments or run up a bill you can’t pay back, credit cards can be costly and can lead to a spiral of debt. 

How does a credit card work?

A credit card allows you to spend money up to a pre-set limit. You’ll get a bill for what you’ve spent each month.

It‘s important to try to pay off the balance in full every month. But you’ll need to pay off at least the minimum amount.

The minimum is set by your credit card provider, but must be at least 1% of the outstanding balance, plus interest, any default charges and the annual fee (if there is one). Most of the time it will be between 3 and 5%. It might also be set as a pound figure of at least £5.

If you pay off the bill in full, you won’t pay any interest on what you’ve borrowed unless you have used your credit card to withdraw cash.

If you don’t pay off the bill in full, you’ll be charged interest which is usually backdated to the date of your purchase

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Things you need to know about credit cards

There are some important points you need to keep in mind before applying for and using a credit card:

  • The credit card provider will carry out a hard credit check when you apply. This will include checking your credit file. If you’ve got a good credit rating, this will improve your chances of a successful credit application. It could also give you access to cards offering the lowest interest rates and/or promotional offers. A hard credit check will show up on your credit report and will have the potential to affect your credit score.
  • Some credit companies will perform a soft check before you apply. This type of credit inquiry will have no impact on your credit rating and will not show up on your credit report. It provides an indication of whether your credit application will be successful.  
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  • If your application is accepted, the card provider will give you an agreed credit limit. This is the most you’re allowed to spend on the card and can be anything from a few hundred to several thousand pounds.
  • You need to make at least the minimum payment each month, even during an interest-free period. You can pay your bill in a number of ways, which will be explained on your bill. If you’re worried about forgetting to pay, you can set up a Direct Debit. This is providing you can rely on enough money coming into your bank account on the same date each month. This will mean you don’t miss a payment, which could lead to unwanted charges and the loss of any introductory rate. Missing or late payments could also damage your credit rating.
  • Credit cards aren’t suitable for cash withdrawals because of fees. If you do withdraw cash on your credit card, you’ll usually be charged a fee plus interest (at a higher rate) daily from the day you take your cash.
  • You need to be at least 18 to apply for a credit card. With some cards, the minimum age is 21.

Is a credit card for me?

If you already struggle with managing your money or you think you might be tempted to overspend, it‘s important to avoid getting a credit card.

Are you confident about managing your spending and being able to clear your balance every month? Then a credit card can be a good way to buy what you need now and pay for it each month.

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Pros of credit cards

  • Easy to carry, easy to use – credit cards are accepted at more places than charge cards and prepaid cards.
  • Safer than cash – if your card is lost or stolen, just call your bank and cancel it. If it’s stolen and used fraudulently, you’re much more likely to get the money back.
  • Might be a cheaper way to borrow – if you pay off your outstanding balance in full each month, you won’t pay any interest. However, some cards offer an initial interest free period on purchases.  But it’s important to be aware of when your interest-free period ends and if any kind of spending doesn’t count during this period.
  • You’re protected – with credit cards, you’re protected for most purchases over £100 and up to £30,000 under something called Section 75. So if you book a holiday and the provider goes out of business, the card company should cover the cost even if you only paid an initial deposit by card. You might also be protected for  purchases under the ‘chargeback’ scheme should section 75 not apply but Chargeback is not a legal right (unlike Section 75).
  •  Freebies – these often come with credit cards, such as air miles, reward points and cashback. But it’s important to never choose a credit card just because of the fringe benefits. 
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  • Can help your credit score – sticking to your credit limit and paying your credit card balance in full each month can improve your credit rating. But missing even a single payment will damage your credit record. So it’s important you don’t miss payments 

Cons of credit cards

  • High-interest payments – if you don’t clear your balance at the end of each month (and you’re not on a 0% deal), you’ll have to pay interest on your outstanding balance. This can be a lot more than other forms of borrowing.
  • Beware the debt spiral – miss just one payment and the interest will start to add up. Unless you pay off what’s owed each month, you can quickly spiral into debt, especially if you continue spending on your card.
  • Can damage your credit score – if you miss a payment or go over your credit limit you can severely damage your credit score. This can affect your ability to borrow money in the future.
  • Additional fees – as well as the interest, you could find yourself paying extra fees or penalties for exceeding your credit limit,  or missing a payment. You will usually have to pay a higher rate of interest for withdrawing cash and some credit cards may also charge an annual or monthly fee.
  • Deposits and pre-authorisations can cut into your credit limit – some places, such as, hotels or car rental firms might use your credit card to take a pre-authorisation. This is so they can charge you if you use things like the mini-bar and don’t pay for it. They’ll put a hold on part of your credit limit – say, £500 – and while it’s in place that amount of credit will be unavailable to you. Even after they remove the hold, there might be a few days’ wait until your credit limit is back to normal.
  • Expensive to use abroad – this very much depends on the card. Some are designed for travellers; others are more expensive when it comes to fees and other charges. This depends on whether you use the card for purchases or cash withdrawals. Shop around to find the best rate cards to use abroad.

Charges and fees

Be careful how you use your credit card. There are all kinds of ways you can incur charges.

Watch out for interest rates

If you don’t pay off your credit card balance in full at the end of the month, you’ll pay interest on your whole balance. This is unless you’re in a 0% introductory period.

As a new customer, you might get an introductory rate when you first get the card. But check whether this covers purchases or balance transfers or both. Remember, it won’t cover cash withdrawals.

Also, check what the interest rate will be once the introductory period is over and make sure you repay in full before then if you can.

Fees for transferring to another card

If you’re transferring a balance from another card, you’ll usually be charged a fee, often around 2-4% of the amount transferred.

You need to work out whether it’s worth paying this in order to benefit from a lower interest rate on the card you’re transferring to.

Late payments damage your credit rating

If you make your payment after the monthly deadline on your statement, you’ll have to pay a late payment charge.

Any 0% or other introductory rate could also be withdrawn. Plus, other companies will see you were late paying as part of your credit record.

This could have a negative impact on future credit applications, such as applying for a mortgage or a car loan.

Minimum credit card payments can get out of control

Always aim to repay as much as you can. If you only make the minimum payment, it’ll take a long time to pay off your debt and you’ll end up paying a lot more than you borrowed.

For example, if you had a £1,000 balance, are charged 22% interest and no longer use the card:

Monthly repayment
Total interest
Total cost
Time taken to clear balance

£30

£474

£1474

4 years and 2 months

£100

£104

£1104

12 months

By paying £70 more each month, you’d pay £370 less in total and pay off your debt three years and two months earlier.

If you feel you’re not able to manage your repayments or you’ve been contacted by your card provider, help is available.

Credit card providers are obliged to contact and encourage people who have made very low or minimum payments on their credit cards for the past 18 months. This is where you have paid more in interest, fees and charges than what you have paid back to get the balance down on your credit card. 

Lenders are required to suggest higher affordable repayments. If you do not respond, or ignore the issue, and the situation persists for more than 36 months this could lead to your account being suspended.

Cash withdrawals cost money

Credit and debit cards work differently at cash machines.

With a debit card, there are no fees unless you’re using a privately operated cash machine. If a fee is charged, you’ll be told how much you’ll be charged before you take the money out.

With credit cards, your card provider will charge you a minimum amount or a percentage of your cash withdrawal if you take money out from any type of cash machine.

You might not be told about this before you take out the money. You’ll also start being charged interest by your card provider straight away, even if you pay it all off before your bill is due.

The same applies to other transactions that are treated as cash – such as using a credit card to purchase foreign currency or gift cards, or for gambling transactions.

It’s best to avoid taking out cash on a credit card.

Credit card cheques come with fees

A credit card cheque is like a normal cheque but the money goes on your credit card bill instead of coming out of your bank account.

They’re expensive to use and it’s best to avoid them. They’re treated like a cash withdrawal, so the interest rate is higher and there are additional fees on top.

Credit card cheques don’t have the same protection for your purchases as card transactions. They’re not  as popular as they used to be, and you have to ask for them from your card provider. 

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MoneyHelper is the new, easy way to get clear, free,
impartial help for all your money and pension choices.
Whatever your circumstances or plans, move forward with MoneyHelper.

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MoneyHelper is the new, easy way to get clear, free,
impartial help for all your money and pension choices.
Whatever your circumstances or plans, move forward with MoneyHelper.

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