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How do credit cards work? A guide for dummies and beginners

Understand how credit cards work, what they cost and what types are available for first-timers.

Credit cards give you a way to buy what you want now and pay it off later, over time. You can spend a set amount, known as your credit limit, and receive statements each month. Typically, you pay interest when you carry a balance on your card. However, there are ways to avoid interest, including interest-free days, 0% interest rate offers and cards that charge a monthly fee but no interest. Other standard credit card features you need to know about include annual fees, rewards and complimentary extras.

Here, we explain the key features and standard costs of a credit card so you can find the right one for your budget. You can also find out what types of credit cards are suited to beginners and the mistakes you should avoid to get your credit card history off to a good start.

How does a credit card work?

A credit card is an unsecured revolving line of credit. “Unsecured” because there is no asset as collateral (such as a car or home) and “revolving” because you can use the card on an ongoing basis (unlike, say, a personal loan that you use and pay off over a set term). So you use the card for your spending, then receive a monthly statement that tells you the total amount you owe for that billing period. You then have the choice to pay some or all of the amount, with a minimum required payment that’s usually around 2-3% of what you owe.

The maximum amount you can spend with your credit card is known as your credit limit. Your credit card provider assigns the credit limit based on your perceived ability to make repayments, income, credit history, and credit score. Some cards have a lower minimum credit limit, while others have a minimum limit of $5,000 or more.

In New Zealand, the main credit networks used are Visa and Mastercard. Visa and Mastercard don’t issue credit cards, but instead, major banks do so on their behalf. American Express is another credit card network, which provides cards directly to customers.

How credit card interest works

When you pay with a credit card, your spending attracts interest charges unless it is eligible for an interest-free period. When interest does apply, there could be different rates depending on the type of transaction. For example, the interest rate for purchases typically ranges from 9.95% p.a. to 25.99% p.a., while for cash advances, it is around 12.95% p.a. to 27.50% p.a.

Credit card interest is calculated based on your account’s daily outstanding balance, then charged monthly at the end of the statement period, which means you could save on interest charges by making more than one payment per month.

What are the costs of a credit card?

  • Repayments. Although you have to make the minimum repayment when your statement is issued, you’re free to repay as much as you like and as often as you like beyond this minimum. The minimum repayment is usually 2% or 3% of your outstanding balance, so it’s best to pay your account in full (or as much as you can) each statement period to reduce your interest costs. You pay a late payment fee if you don’t make the minimum repayment by the due date.
  • Annual fee. The annual fee is the cost of the credit card account. Annual fees range from $0 to $390 or more depending on the type of credit card. The credit card annual fee is deducted from your available credit limit and accrues interest at the purchase rate if you don’t pay it in the first statement period.
  • Interest rates. Interest is the price you pay to borrow money. Credit card interest rates are much higher than other types of finance because credit cards are an unsecured product, which means financial institutions cannot take your assets if you default on your repayments. However, you can avoid interest charges if you take advantage of interest-free days. You could also save on interest with a card that offers 0% p.a. for an introductory period.
  • Other fees. Other fees you may run into include late payment fees, over-limit fees (a fee for spending past your credit limit), rewards programme membership fees and cash advance fees.

Credit card features explained

  • Credit limit. The credit limit is the maximum amount of money you can borrow using your credit card. While you can request a specific credit limit at the time of application, the provider determines your credit card limit based on your income and credit history. Note that minimum credit limits apply and can range between $500 and $15,000, depending on the card. While you don’t have to spend all your credit limit, you want to ensure that the minimum credit limit doesn’t exceed the maximum you had in mind.
  • Interest-free days. Most credit cards give you a way to make interest-free purchases by offering up to 44 or 55 days interest-free. The interest-free period begins on the first day of your statement period and runs through to the due date for payment at the end of that statement period. Interest-free days usually only apply if you pay your entire balance in full.
  • Balance transfers. Suppose you’re struggling to pay off existing debt. In that case, you can transfer the balance to a credit card with a different provider and get an introductory low or 0% interest rate on the balance transfer for a period, which gives you time to pay down your debt while paying low or no interest rate on the balance. If you still have debt from the balance transfer at the end of the introductory period, a higher interest rate applies.
  • Cash advances. Using your credit card to get cash from an ATM for gambling purchases or paying specific bills are cash advance transactions, which attract a cash advance fee.
  • Rewards programmes. A rewards credit card gives you a way to receive points when you pay by card. Usually, you earn points through a rewards or Airpoints programme and redeem them for travel, gift cards, retail items or cash back. A few cards offer cashback rewards instead of points. Many rewards cards also offer bonus points when you meet a spend requirement after signing up. However, these cards often come with higher annual fees and purchase rates.
  • Contactless payments. For purchases under $80 (Some providers have increased this limit to $200), tap your credit card against a contactless reader to complete a purchase in seconds. Some cards also offer contactless mobile payments when you add them to Apple Pay, Google Pay, Samsung Pay and other mobile wallets.
  • Insurance covers. Many credit cards offer complimentary insurance, ranging from purchase protection insurance and extended warranty cover to overseas medical travel insurance and transit accident insurance. Usually, the more premium cards provide more comprehensive cover, but it’s always worth checking the insurance information booklet for full details.
  • Extra features. Credit cards may come with extras such as best price guarantee cover, complimentary airport lounge access, concierge services, invitations to exclusive events, discounts with partnered retailers and much more.

    pile of colorful credit cards

    What types of credit cards are suitable for beginners?

    In New Zealand, Visa, Mastercard and American Express issue credit cards. There are many types of credit cards with different features for different kinds of borrowers. For example, low-rate credit cards feature a low purchase rate of interest and annual fees. In contrast, rewards credit cards feature high-interest rates and annual fees but compensate cardholders with points for purchases. Therefore, it is generally wise to begin with, to have a no-frills credit card to get a grip on how credit cards work before upgrading to a product with bells and whistles.

    These types of credit cards are suitable if you’re starting:

    • Low-interest credit cards. Low-interest rate credit cards typically feature a low purchase rate of interest, which is beneficial if you don’t pay back your balance in full by the statement due date. These types of credit cards may also feature a promotional period in which you pay low or no interest on credit card purchases. Low-interest credit cards are suited to beginners finding their feet making repayments. Paying off debt over a couple of months is far cheaper with a low-rate credit card compared to a rewards or premium credit card.
    • No annual fee credit cards. This credit card type costs nothing to own, but the interest rates are usually higher than low-rate credit cards. On the other hand, a no annual fee credit card can sit in your wallet, never come out, and won’t cost you a thing. These types of credit cards are suited to beginners looking to build their credit history but don’t want to go all-out on a credit card with loads of features.
    • Low-income credit cards. Low minimum income credit cards have a low credit limit. The provider wants to make sure you can comfortably make credit card repayments after meeting your other monthly expenses. Low-income credit cards are typically either low-interest rate or low fee credit cards. They are suited to beginners who either have a low income or want a low credit limit to avoid the temptation to overspend.

    What about rewards credit cards?

    If you want a credit card to earn rewards as you spend, a key factor is to make sure you get more value from rewards than you spend on the card. Ensure you choose a rewards card with a low or $0 annual fee, and make sure you pay off the entire balance each month (so you get interest-free days for purchases), choosing rewards based on their dollar value – or a mix of tactics. You can check out Finder’s rewards credit cards guide to learn more about them and compare different options.

    Compare No Annual Fee and Low Income Cards

    Name Product Purchase Rate Annual fee Balance Transfer Rate
    AIRPOINTS
    American Express Airpoints Card
    0% for 6 months (changes to 19.95% p.a.)
    $0
    N/A
    Be rewarded with 100 bonus Airpoints Dollars when you apply by 28 February 2022, are approved and sped $750 on your new card within the first 3 months of membership. This offer is available to new Card Members only.
    Kiwibank Zero Visa
    13.95% p.a.
    $0
    1.99% p.a. for 6 months
    1.99% on balance transfers for 6 months.
    LOW RATE
    ANZ Low Rate Visa Credit Card
    12.9% p.a.
    $0
    1.99% p.a.
    Balance transfer offer: Pay 1.99% p.a on balances transferred for the first two years. Ts&Cs apply.
    ASB Visa Light
    13.5% p.a.
    $0
    0% p.a. for 6 months
    0% p.a. interest for 6 months on any purchase of $1,000 or more with ASB Smart Rate.
    LOW RATE
    Westpac Low Rate Mastercard
    12.9% p.a.
    $0
    5.95% p.a. for the life of the balance
    Low rate of 5.95% for all balance transfers for the life of the balance.
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    Compare up to 4 providers

    Name Product Purchase Rate Annual fee Balance Transfer Rate
    AIRPOINTS
    American Express Airpoints Card
    0% for 6 months (changes to 19.95% p.a.)
    $0
    N/A
    Be rewarded with 100 bonus Airpoints Dollars when you apply by 28 February 2022, are approved and sped $750 on your new card within the first 3 months of membership. This offer is available to new Card Members only.
    LOW RATE
    ANZ Low Rate Visa Credit Card
    12.9% p.a.
    $0
    1.99% p.a.
    Balance transfer offer: Pay 1.99% p.a on balances transferred for the first two years. Ts&Cs apply.
    AIRPOINTS
    Kiwibank Air New Zealand Airpoints Low Fee Visa
    16.9% p.a.
    $25
    1.99% p.a. for 6 months
    1.99% on balance transfers for 6 months.
    TSB Visa Classic Credit Card
    18.5% p.a.
    $30
    0% p.a. for 6 months
    Pay 0% interest for the first 6 months on all balance transfers.
    ANZ CashBack Visa Credit Card
    19.95% p.a.
    $60
    N/A
    AIRPOINTS
    Kiwibank Air New Zealand Airpoints Standard Visa
    20.95% p.a.
    $65
    1.99% p.a. for 6 months
    1.99% on balance transfers for 6 months.
    BNZ Lite Visa
    12.9% p.a.
    $30
    N/A
    LOW RATE
    Kiwibank Low Rate Visa
    9.95% p.a.
    $30
    1.99% p.a. for 6 months
    1.99% on balance transfers for 6 months.
    BNZ Advantage Classic Credit Card
    20.95% p.a.
    $40
    N/A
    Get 1 Flybuys point for every $40 of eligible spend or $1 cash reward for every $150 of eligible spend.

    LOW RATE
    Westpac Low Rate Mastercard
    12.9% p.a.
    $0
    5.95% p.a. for the life of the balance
    Low rate of 5.95% for all balance transfers for the life of the balance.
    Westpac hotpoints Mastercard
    20.95% p.a.
    $44
    5.95% p.a. for the life of the balance
    Low rate of 5.95% for all balance transfers for the life of the balance.
    Westpac hotpoints Platinum Mastercard
    20.95% p.a.
    $119
    5.95% p.a. for the life of the balance
    Low rate of 5.95% for all balance transfers for the life of the balance.
    AIRPOINTS
    Westpac Airpoints Business Mastercard
    20.95% p.a.
    $145
    5.95% p.a. for the life of the balance
    Low rate of 5.95% for all balance transfers for the life of the balance.
    AIRPOINTS
    Westpac Airpoints Mastercard
    20.95% p.a.
    $55
    5.95% p.a. for the life of the balance
    Earn 1 Airpoint Dollar with every $130 spent and get 55 days interest-free credit on all purchases.
    Westpac BusinessPlus Mastercard
    20.95% p.a.
    $100
    5.95% p.a. for the life of the balance
    Earn 1.25 hotpoints for every dollar of eligible business spend.
    BNZ Advantage Visa Platinum Credit Card
    18.95% p.a.
    $90
    N/A
    1 Flybuys point for each $15 you spend or $1 in cash rewards for each $90 of eligible spend.
    AIRPOINTS
    ANZ Airpoints Visa Credit Card
    19.95% p.a.
    $65
    N/A
    Earn 1 Airpoints Dollar for every $130 you spend on your card.
    AIRPOINTS
    Westpac Airpoints Platinum Mastercard
    20.95% p.a.
    $150
    5.95% p.a. for the life of the balance
    Low rate of 5.95% for all balance transfers for the life of the balance.
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    Compare up to 4 providers

    Applying for your first credit card

    Credit cards are a product for borrowers with a good credit history. If you’ve never applied for a credit product before, you have a better chance of being approved for a basic credit card than a credit card packed with extras. The credit card company wants to see copies of your latest payslips to verify your income and documents to verify your identity.

    While most institutions require you to apply for a credit card in your name, some let you apply for a joint account with your partner. If you want to provide someone else with access to your account, you can nominate additional cardholders.

    Eligibility requirements

    To be eligible for a credit card, you need to meet the following criteria. Note that some cards may have additional requirements.

    • Minimum income. The minimum income is how much you need to earn every year to be eligible to apply. The credit card issuer wants to make sure you can make credit card repayments after meeting your other monthly expenses.
    • Age. You must be over the age of 18.
    • Residential status. You must be a citizen or a permanent New Zealand resident. Some financial institutions offer credit cards to applicants with a student or temporary resident visa.
    • Good credit history. You must have a good credit history to apply, which includes no current defaults. If you have not built up a credit history to date, you are not penalised but may only be eligible for a low credit limit. As you build a credit history using your credit card, you can apply for a limit increase later.

    Necessary documents

    • Income information. You need to provide copies of your most recent payslips to prove your income. If you’re self-employed, you can provide your tax return instead.
    • Identification. You need to verify your identity with the credit card company before it finalises your application. You can do this by providing your driver’s licence, passport, community services card or Kiwi Access Card (18+).

    Most banks and providers give you a response within 60 seconds of completing the online application, and if you receive approval, you receive your card in the mail about ten days later.

    Dos and don’ts of your first (or any) credit card

    Here are some mistakes to avoid and good credit card habits to get into:

    Do

    • Make regular repayments. Credit cards are not free money. You need to make at least the minimum repayment every month so you can avoid late payment fees, stop your account from going into default and maintain a good credit history. However, it would be best if you always aimed to pay more than the minimum to avoid falling into debt.
    • Stay within your budget. Having a credit card means you can temporarily spend more money than you have, which can make it tempting to buy things you normally wouldn’t. The best practice is to treat your credit card as if you were spending your own money, and if you need to spend more, pay it off as soon as possible.
    • Educate yourself. It’s essential to understand how credit cards work. For example, remember that ATM withdrawals count as cash advances and immediately charge a higher interest rate. Even if you have a 0% purchase or balance transfer offer on your card, you still need to make repayments each month and can only take advantage of interest-free days when you pay your balance in full. Understand the fees and charges that come with most credit cards before you apply or at least as soon as you get your card.

    Don’t

    • Make cash advances. When you use your credit card to get money from an ATM, gamble or pay specific bills, the provider charges a cash advance fee and a cash advance interest rate, which can be as high as 28% p.a. Furthermore, interest-free days do not apply when you use your credit card for a cash advance.
    • Share your credit card information. Apart from directly logging into your online banking or your bank’s official app, do not enter your credit card information or log-in details into any email, text message or a third-party website, except for making purchases from a trusted source.
    • Apply for a credit card you can’t afford. For most people applying for their first credit card, this is a no annual fee or low rate credit card. Rewards credit cards can be a great way to get something for nothing, but these products generally charge higher annual fees and interest rates.

    If you still have questions about how credit cards work, reach out to us using the form at the bottom of the page, and a member of the Finder team will be in touch.

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