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. Find out more about how credit cards work, and if they would be the best option for you.
A credit card lets you spend money on credit – it’s like having a loan for the amount you spend using the card. You can spend up to a pre-set credit limit, which might be a few hundred or several thousands of pounds.
It depends on how confident your card provider is that you’ll pay it back.
If you pay off the bill in full each month, you won’t pay interest on what you’ve borrowed. If you make cash withdrawals though, interest is usually charged on a daily basis from the day you take your cash.
This is one of the reasons why you should avoid taking cash out using a credit card. You’ll be hit with charges – up to 4% or more with some companies. The interest rate for cash withdrawals is also usually higher than for purchases.
If you don’t pay off any outstanding balance in full then interest will be charged.
It’s usually backdated too, so if you bought something at the start of the month you’ll be charged a whole month’s interest.
Around 60% of people who have credit cards pay off the total balance each month.
Source: UK Cards Association
There are some important points you need to keep in mind before applying for and using a credit card.
Be careful how you use your credit card. There are all kinds of ways you can incur charges.
If you don’t pay off your credit card balance at the end of the month, and you’re not in a 0% introductory period, you’ll pay interest on the whole of the statement balance, not just the part you haven’t repaid.
New customers beware! 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.
If you’re transferring a balance from another card, you will usually be charged a fee, often around 3%.
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.
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. On top of this, other companies will see that you were late, as part of your credit record.
This could have a negative impact on future credit applications like applying for a mortgage.
When you get your credit card statement you can choose to pay off a minimum amount, the whole thing or any amount you choose.
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.
If you had a £1,000 balance, are charged 18% interest and no longer use the card:
|Monthly repayment||Total interest||Total cost||Time taken to clear balance|
|£30||£353||£1,353||3 years and 10 months|
By paying £70 more each month you’d pay £268 less in total and pay off your debt 2 years and 11 months earlier.
Credit and debit cards work differently at cash machines. Debit cards are mostly free or tell you if there’s a charge.
If you use your credit card you might pay a fee every time you take out cash and you might not be warned of the extra cost when you use the machine.
Fees can be as much as £5 per withdrawal. You’ll also be charged interest on the money, even if you pay it off by your card repayment date.
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 make gambling transactions.
With fees and interest, avoiding taking out cash on a credit card is the best advice.
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 much less popular now and you have to ask for them from your card provider. As with cash withdrawals, they’re very expensive to use and the best advice is to avoid them.
This article is provided by the Money Advice Service.