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How do credit cards work?

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Everybody understands how credit cards work, don’t they? They look simple enough but too often they lure users in to serious financial difficulties.

For most people, a credit card offers a simple and convenient way to spend money in shops, bars and restaurants, or order stuff online.

Shop around for the best credit card deal, then get ready to have some fun.

Unfortunately, for some the fun does not last. Britons owe a mind-boggling £70 billion on credit cards, and if you don’t know how they work, they could end up working against you.

Get the right balance

The charm of credit cards is that they allow you to borrow money for free, but only for a limited period.

Most grant you an interest-free period of up to 56 days on purchases.

This means if you pay off your bill in full each month, you will pay no interest at all on your borrowings. By comparison, if you spend money on a debit card, it is instantly drawn from your bank account.

This makes credit cards hugely attractive, but if you do not pay off your balance in full each month then you will start paying a hefty APR.

Treat this as short-term borrowing, not long-term debt.

Wrong rate

APR is short for the’ annual percentage rate’, which is typically around 19.9%, although some charge more.

Given that you can get mortgages or personal loans from around 4%, credit card APRs are not cheap.

You must meet your minimum repayment every month, otherwise you will face an instant penalty, £12, and damage your credit record. You might also face a £12 penalty for exceeding your credit limit.

This is how credit card companies can afford to lend you money for free: by imposing punitive charges on those who do not pay their bills on time.

Risky gamble

Credit cards can be useful for larger purchases, as you can spread the repayments over a number of months.

What you must not do is use them for everyday spending (unless you clear the bill in full every month) as then you are living beyond your means.

Also try to avoid using them to withdraw cash or gamble online, as interest starts rolling up immediately.

Plastic fantastic

Warnings aside, there are plenty of reasons to take out a credit card.

You get protection against faulty items or bankrupt suppliers on purchases costing between £100 and £30,000, under Section 75 of the Consumer Credit Act.

There are also some hugely attractive credit card deals: for example, you could apply for a balance transfer credit card to shift your existing debt to a 0% rate.

Or for interest-free credit card purchases, you can choose from a wide range of 0% credit cards.

Alternatively, find the best rewards credit card for your spending patterns.

If you have had previous money problems, search for the best credit cards for bad credit.

Now you know how they work, make sure you play your cards right!

5 Things You MUST Check Before You Apply For A Credit Card

Thanks to the research we've done for you, you should have a good idea of which credit card suits your needs best. Now there's just one more important page you need to read: "5 Things You MUST Check Before You Apply For A Credit Card" is a special report from The Motley Fool, and it's completely free!

This expertly prepared report will inform you how to repair your credit history, explain why your credit report may contain errors and how you can fix these, as well as guide you through exactly how the UK credit scoring system works and why you need to understand it. All that's left to do is click here for access, and it won't cost you a penny!

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