The beginner’s guide to credit cards
Understand how credit cards work, what they cost and everything you need to know about choosing the right one for you.
Once you get the hang of them, you’ll find that credit cards are incredibly helpful financial tools. Instead of carrying cash, you can make purchases with a convenient little piece of plastic.
Using a credit card comes with a host of benefits that include payment protection, the option to pay for your purchases over time, rewards for spending and more.
Ready to get started? Here’s everything you need to know about credit cards.
What's in this guide?
What is a credit card?
When a bank gives you credit, it lets you buy things now and pay for them later.
So when you use your credit card, you haven’t spent money out of your own pocket. Instead, you’ve borrowed money from your bank to pay for your purchase. Later, you’ll repay your bank for what you’ve bought.
In a moment, we’ll dive deeper into how credit cards work.
A credit card is…
- A convenient way to pay. Do you need to buy a £250 TV? You won’t need to take a ton of cash to the store — just use your card.
- A way to build your credit score. A strong credit score can help you get a mortgage, competitive interest rates on loans and more.
- A fairly secure payment method. Credit card issuers have robust fraud departments, and in addition must offer protection if things go wrong – like a merchant going out of business.
A credit card is not …
- Free money. Whenever you swipe your card, you’ll need to pay for your purchases sooner or later. Furthermore, you’ll pay interest if you carry a balance on your card month to month.
- A debit card. When you swipe a debit card, money is taken out of your bank account immediately. With a credit card, swiping means borrowing money from your provider. You need to pay that money back later.
- An ATM card. You can use your credit card at many locations, not just at ATMs. However, if you use your credit card at an ATM, watch out for cash advance fees.
- A loan. You don’t have to obtain money from your bank in advance. You’ll only owe money to your bank or provider when you make a purchase, meaning you’ll only pay interest on the amount that you use.
- Unlimited money. Your card will come with a credit limit — the maximum amount you can carry on your card.
Types of credit cards
There’s a universe of credit cards out there, and it can be fun searching for your ideal pick. Here are the different card types you’ll find on the market.
Different types of credit cards
Low rate credit cards
These cards are all about paying as little interest as possible, with features like:
- Low or 0% interest on purchases. These cards typically offer a low interest rate indefinitely or, more commonly, a 0% interest rate for a specified number of months, reverting to a higher rate later.
- Low or 0% interest on balance transfers. With a balance transfer, you move your existing credit card debt to another card to enjoy a better rate for an agreed period, reverting to a higher rate later.
Rewards credit cards
Rewards cards provide bonuses for your everyday spending, such as:
- Cashback. With a cashback card, you’ll get a percentage of your spending back. For example, if you spend £1,000 and get 1% cash back, you’ll receive a nifty £10.
- Loyalty points. Schemes such as Nectar let cardholders earn points whenever they spend, to redeem later. Higher earn-rates may apply for spending at specific merchants.
- Travel. With a travel card, you’ll accrue points or miles that you can later redeem for travel perks around the world.
Credit repair cards
A credit builder credit card is relatively easy to get. It won’t offer much in the way of savings or rewards, but it does help you build or rebuild your credit.
- Low credit limits, with regular reviews. OK, so you’re likely to start with a low credit limit, around the £500 mark but keep up to date with your repayments and this could be reviewed in as little as four months.
- Relatively easy to get approved for. Since these cards are designed for those with bad credit, or very limited credit history, you obviously won’t need a top-notch credit score to get your hands on one.
Balance transfer credit cards
A balance transfer credit card is card designated to help you clear an exisiting balance or organise your debts into one place.
- Low or 0% interest cards. Most balance transfer credit cards come with low or no interest for a set period of time, allowing you to pay of your debts as cheaply as possible.
- No balance transfer fee cards. Typically with the longer 0% interest period offers, you can expect to pay a fee to balance transfer. However, there are some cards that come fee-free, albeit the introductory period might be shorter or the card might have none at all.
Specialty credit cards
There are a few other “niche” types of card available:
- Gold, platinum or Black. These are the premium cards, often with hefty annual or monthly fees but also high credit limits and plenty of perks, such as travel insurance, airport lounge access and more.
- Business. With this card type, you’ll typically be allowed a much larger number of cardholders per account, and potentially more points, miles or cashback on business-related expenses.
- Student. These cards are designed for customers with little or no credit history.
How do credit cards work?
Here’s the lowdown on how credit cards work. Once you understand the mechanics behind your card, you’re on your way to using it responsibly.
Credit card mechanics
Using your credit card means that you’ll repay your bank later for your purchases. But when do you have to pay? To find out, you need to know about your card’s billing cycle.
A billing cycle doesn’t necessarily line up with each month. It can run from, say, the 1st to the 31st, but it can also start from the 25th of one month to the 25th of the next month, and so on. To know for sure, ask your card provider. You’ll also see how long the cycle is once you receive your first bill.
At the end of each cycle, your bank will collect up all the transactions you’ve made and send you a bill. When you receive your bill — called your credit card statement — it’s time to decide what to pay. To avoid paying unnecessary interest, it’s a good idea to pay your entire balance. But you can also choose to pay the minimum amount possible or some amount in between. The amount you pay will decide how much interest you owe.
Most banks will allow you to set up a direct debit where you can specify that you’d like to automatically clear the full balance each month, or that you’d like to pay the minimum requested amount each month. This is generally worth doing, as it ensures you never miss a payment. Missed payments would not only get you in hot water with the card issuer, but could also damage your credit record and bring about the termination of any promotional offers you are enjoying, such as a 0% interest period.
You don’t have to wait for your bill to arrive before repaying your bank. If you’d like, you can pay off your balance immediately.
How does interest work?
Many people shy away from credit cards because they’re worried about interest. Interest is a fee for borrowing money, and it’s calculated as a percentage of the amount borrowed.
However, the good news is that you won’t owe interest if you pay your bill in full (i.e. completely clear your outstanding balance) within a certain amount of time. Your card provider will typically give you a grace period to pay off your purchases. If you pay your entire balance within this period, you won’t be charged interest.
If you pay less than your full balance by the due date, the remainder will accumulate interest. At the very least, you need to repay the minimum payment each month, typically 1% to 3% of your total balance. Be careful about carrying a balance on your card – if you spread the cost of every purchase you won’t be doing yourself any favours, and the debt will soon rack up.
Confusingly, credit card issuers often charge interest at different rates for different types of balances. Cash advances (money withdrawn at cash machines) will normally accrue interest at a higher rate to purchases (as well as incurring a fee) while balances transferred from your old credit card are likely to accrue interest at yet another rate.
Many providers charge an annual fee to use their credit card — a fee you have to pay once a year to remain a cardholder. An annual fee can reduce the benefit of your card, so factor them in when comparing cards.
You may see an introductory annual fee for the first year. This means you’ll pay a discounted fee for the first year and then the stated annual fee every year thereafter.
Keep an eye out for other fees, that could include:
- Balance transfer fee. For moving your existing credit card debt to your new card, usually between 1 and 3% of the total balance you transfer.
- Cash advance fee. For using your card to collect cash, such as a cash withdrawal or buying foreign currency on your card.
- Foreign transaction fee. For using your card outside the UK, you could pay between 1% and 3.5% of your transaction.
- Late payment fee. For paying at least your minimum after your statement due date. This could be up to £12.
- Returned payment fee. For sending a payment that bounces — for instance, if you enter your bank account number incorrectly. This fee could be up to £12.
A credit card offers a revolving line of credit, but what exactly is that?
Suppose you took out a £5,000 loan with a bank over 2 years. They’d give you the lump sum on day one, and it would start accruing interest straightaway. Then you’d make a set repayment each month for two years, after which the debt would be cleared and the account would be closed.
Now suppose instead of the loan, you took out a credit card with a £5,000 limit. You’d get issued a card on day one, but you’d only start accruing interest if and when you used the card to buy something, and you’d only be charged interest on the amount you had spent, rather than on your full credit limit. Then, later you could either pay the balance off in full, or simply pay the minimum required payment. The debt might be cleared after a week, or after several years. A credit card could theoretically last for the rest of your life, with the amount you owe rising and falling according to how much you spend and how much you repay – the debt doesn’t have an end date. That’s a revolving line of credit.
How do credit card companies make money?
- Interest. Outside of promotional and grace periods, cardholders pay interest on their outstanding balance.
- Interchange fees. Issuing banks charge fees to merchants for processing credit card transactions.
- Card fees. Annual fees, balance transfer fees, cash advance fees, late fees and more add to a provider’s coffers.
Issuers and networks… What’s the difference?
A credit card is offered by a bank — HSBC, for example. But if that’s so, why does your card also have a Visa or Mastercard logo?
It’s because credit cards are supported by both issuers and networks.
What an issuer does
- Considers cardholder applications
- Issues credit cards
- Resolves customer issues
- Provides lines of credit to customers
- Sets terms and conditions for credit card accounts
What a network does
- Maintains and promotes the card network
- Sets interchange fees
- Serves as an intermediary between acquiring banks and issuing banks
Interchange fees, acquiring banks and issuing banks explained
For consumers, swiping a credit card is a simple task. However, a complex process takes place behind the scenes.
A merchant (for example a shop where you can purchase goods using a credit card) sends notice of transactions to its acquiring bank. This “acquirer” pays the merchant.
Afterwards, the acquirer sends the transactions through a card network like Visa or Mastercard that forwards the transactions to respective issuing banks. Issuers are the ones that distribute cards to customers.
Issuing banks charge interchange fees, which are processing fees for credit or debit card transactions. Card networks get a cut of these fees. Then the acquirer receives the remaining funds.
As a consumer, you won’t deal with interchange fees or acquiring banks, just with your issuing bank. Your issuer is the one you’ll make payments to and call if you have problems with your card.
Credit cards and credit scores
When you apply for any form of credit from a lender, your credit score matters. Lenders check your credit report to assess risk – in other words, to gauge their chances of getting their money back.
Your credit history is collected and stored by credit reference agencies. The biggest in the UK are Experian, Equifax and TransUnion (formerly Callcredit).
What does a credit score look like?
There is no single, definitive credit score for an individual. Each Credit Reference Agency (CRA) uses a different scale. Lenders will normally check with one or more of these agencies when assessing your application for credit. These are the scoring ranges employed by the main UK CRAs (the higher the number, the better the score).
Depending on your score, you’re said to have excellent, very good, good, fair, poor or very poor credit:
|TransUnion (formerly Callcredit)||0-550|
|1: Very poor|
Having a decent credit score will make it easier to get approved for credit cards, and is also likely to affect the credit limit and interest rate that you’re offered by lenders.
Lenders report credit repayment behaviour back to CRAs, and because your card is a source of credit, it affects your credit report. Keeping up to date with card repayments will be reported back to CRAs and help you to build a positive credit history. In contrast, missing payments will be reported back to CRAs, and will likely have an adverse effect.
As well as account information, your credit report includes public records such as county court judgements (CCJs) and Individual Voluntary Arrangements (IVAs), electoral roll details, information on people financially linked to you and your address history.
Credit card terms you should know
Here are a few important terms you should know when looking for a credit card.
The Annual Percentage Rate (APR) is designed to be a benchmark for consumers, providing an annual summary of the cost of credit. As well as the interest, the APR also takes into account any compulsory charges – like an annual fee, if there is one. However, crucially, lenders only have to award the advertised APR to 51% of those who take out the card – the other 49% could be offered a different (higher) rate, at the lender’s discretion. That’s why it’s often referred to as the representative APR.
Fixed and variable interest rates
A fixed interest rate stays the same for an agreed period. A variable rate can be changed at the lender’s discretion (normally when the Bank of England base rate changes). Credit cards have variable interest rates by default, but some come with introductory, low, fixed rates – say 0% on purchases for the first 24 months.
When you initiate a balance transfer, you move your existing credit card debt onto a new card. Any debt you move will be subject to your new card’s balance transfer rates and fees. Some cards come with an introductory balance transfer rate. With this intro rate, you’ll be charged low or 0% interest on your transferred balance for a specified amount of time, after which your rate reverts to the card’s regular balance transfer rate (which will be much higher).
When you get a cash advance, you use your credit card to take out cash. For example, you might use your card at an ATM. Purchases like gift cards or traveler’s cheques may be classified as cash advances. It’s a good idea to avoid cash advances, because as well as fees, they tend to incur higher rates of interest. Also, they often don’t come with grace periods for interest.
Credit utilisation ratio
Your credit utilisation ratio, sometimes called your debt-to-credit-limit ratio is how much you owe on your credit cards compared with your total available credit (the total of your credit limits). For example, say you have two credit cards with different credit limits: £5,000 and £7,000. If you carry a £4,000 balance on one card, and a £2,000 balance on the other, then you have a total of £6,000 outstanding from £12,000 available, so your utilisation ratio would be 50%. In terms of your credit report, it’s a good idea to keep your credit utilisation ratio at reasonable levels at all times.
Do I need a credit card?
Here are a few good reasons to get a credit card:
- Build or rebuild your credit. A credit card isn’t the only way to build credit, but it’s an excellent choice. When you use your card and consistently pay your bills on time, your credit score will increase.
- It’s a convenient way to pay. Instead of carrying a lot of cash, you can simply tap your card.
- Make a large purchase and pay it off over time. If this is your primary reason for getting a credit card, consider whether the purchase is essential. Also make sure that you can pay off your purchase in good time.
- Make safer payments. Credit cards give you more protection than debit cards when things go wrong, thanks to the Consumer Credit Act. Learn more about credit card refunds.
You may also have good reasons not to get a credit card:
- It can be difficult to control spending. If you habitually overspend, consider holding off on a credit card. You may rack up huge amounts of debt that will be difficult to repay. Work on solving your spending problem, or stick to prepaid/debit cards.
- You’re not able to pay larger amounts toward your monthly balances. Generally speaking, when you spread the costs of purchases, they work out more expensive overall. So if you can afford to pay upfront, it often makes sense to do so.
- You don’t have the right credit score. Find out what your credit score is before applying for a card. It’s certainly no fun getting denied. Also, applying for many cards can adversely affect your credit score. IF you have bad credit, you’ll likely have to start out paying a higher rate of interest while you build better credit, so if now’s not a good time to do that, hold fire.
Comparing credit cards
With so many credit cards on the market, there’s no “perfect” card. Pick one that’s best for your needs by comparing a few factors.
Comparing credit card factors
Your financial situation
It’s best to get a credit card only if you have your finances in order. If you have structural financial problems like chronic overspending, a credit card won’t help — instead, it could make things worse.
It’s easy to rack up large balances on credit cards, especially because most cards don’t require you to pay your bill in full each month. Paying the minimum each month is a particularly good way to find yourself deep in debt.
Beyond considering whether you can spend responsibly, think about how a card can help you reach your financial goals. Maybe you need to make a big purchase and pay it off over time. In that case, a 0% purchase card could be a better choice. If you need to escape from high interest rates on your current card, you could apply for a balance transfer card.
Your credit history
Your credit history will largely determine which credit cards you’ll qualify for. The higher your credit score, the more choices you’ll have.
If you have a good or excellent credit score, you could qualify for premium rewards cards, often considered the best credit cards available.
It will be tougher to get a credit card with bad credit, but you do have options. It’s unlikely that you’ll get a card that offers much in the way of perks and rewards, but the cards available to you could help you build your credit score.
If you’re young, you probably don’t have much of a credit history. Consider starting with a student or credit builder credit card. Both cards can help you learn how to use credit responsibly.
The older you are, the more likely you are to have a credit history. Check your credit score and apply for the cards that you have a good chance of being approved for.
Income is a significant factor when a card provider decides whether to approve you. The reason is simple: Your provider wants to know you have the ability to repay your debt. All else being equal, the higher your income, the more likely your provider is to approve you.
You don’t necessarily have to be employed to get a credit card. As long as you have some source of income, you’re eligible.
Your personal interests
You can find a card that complements your interests. For example, if you like flying with a certain airline, you can get a card that rewards spending with air miles that you can redeem with that airline.
You’ll also find brand-specific cards that reward spending with that particular brand. If you like football, you may be able to find a card affiliated with the team you support.