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How do credit cards work? A complete guide

By:  Sean LaPointe | 20th December 2021

Are you interested in getting a credit card but want to know more about what one is and how it works before you do? Then you have come to the right place.

If used correctly, a credit card can be a useful financial tool that allows you to borrow money, reduce debt or earn rewards. But in order to do any of those things, you first need to know what a credit card is, what types of credit cards are out there and how they work. So let us break it down for you.

What is a credit card?

A credit card is a payment card that allows you to borrow money from a bank, building society or another credit lender to make purchases. By signing up for and using a credit card, you agree to repay the money you borrow, plus any interest or charges that accrue on the amount you owe, until you have paid it off completely.

There is usually a limit to the amount of money you can borrow. This is determined by the credit card company and may differ depending on the lender and your financial situation.

There are also different rules for paying off what you owe, including the minimum amount that you must repay each month to avoid penalties. If you pay off your entire balance each month, you will not have to pay extra in the form of interest.

How do credit cards work in the UK?

Most merchants in the UK accept credit cards, so you can use them to pay for almost anything, including food, clothing, household goods and medicine. Credit cards can also be used in ATMs to advance you money from your account.[1] 

Every month, your credit card company sends you a billing statement that details all of your transactions and charges. Two options are available: you can pay the full amount that you have accrued (and thus avoid interest) or pay a fixed minimum amount and then repay the rest over time. The latter is usually a fraction of the total owed for that billing cycle (about 1% to 3%). This option includes interest charges on the balance, which compound as long as you owe the debt.

What are credit charges and fees?

To understand the main charges that come with a credit card, let’s break them down into two sections: interest rates and general fees.

Interest rates

One of the most important things to note is that every credit card has an interest rate. This is presented as a percentage and it’s what you will be charged on your borrowing. However, there are different interest rates attached to different functions on the card:

You will be able to find details of these rates in your credit card’s summary box online. However, when comparing credit cards, what you are more likely to see is a card’s APR or annual percentage rate. This includes the interest rate on the card, as well as any other charges, such as an annual fee. As the APR represents the annual cost of borrowing, it is a good figure to use when comparing the costs of different cards.

General fees

Something else you can expect from any credit card is that there will be some fees involved. If you use your card wisely, the likelihood is that you won’t encounter any of these – but it is a good idea to know what they are, just in case.

Some cards have other fees attached, such as balance transfer fees or money transfer fees, but that depends on what type of card you have. 

What types of credit cards are there?

As you may have already gathered, there are many different types of credit cards. What type of card that’s right for you will depend on your financial needs. Credit cards aren’t a one-size-fits-all financial product, but the advantage is that there are a number of options to cover most financial situations.

0% purchase cards

A 0% purchases credit card offers you an interest-free period on your purchases. With this type of card, you can make a large purchase and pay it off over a period of time without incurring any interest charges.

0% balance transfer cards

A 0% balance transfer card lets you transfer existing debt to your new credit card, typically interest free. You then have a set period of time in which to pay off the balance before incurring interest charges. Balance transfer cards typically carry a fee that is taken as a percentage of the amount of debt you have transferred.

0% money transfer cards

A 0% money transfer card is similar to a balance transfer card. It enables you to transfer money from your credit card to your current account, essentially providing you with an interest-free loan. Once again, transfers usually have fees attached.

Reward cards

Reward credit cards reward you for spending on your card. Rewards can vary but usually come in the form of points, vouchers or air miles.

Cashback cards

Cashback credit cards are a type of reward card, but instead of points, you receive cashback on your spending. Typically, you automatically earn a percentage of whatever you have spent on the card in cashback.

Travel cards

Travel credit cards are designed with features that make using your card abroad easier. These include no fees for foreign transactions and often no fees for cash withdrawals made while overseas.

Credit cards for bad credit

Not everybody has a squeaky clean credit score, and there are cards that are more likely to accept applicants with a poor credit history. Credit cards for those with bad credit often include features to help manage credit accounts better, such as a lower credit limit and a credit rebuilder feature. However, they typically have higher interest rates.

What are the advantages and disadvantages of credit cards?

While a credit card can be a helpful financial tool, it’s helpful to look at both the advantages and disadvantages to fully understand whether a credit card is right for you.

Advantages of having a credit card

Disadvantages of having a credit card

Who is eligible for a credit card?

To be eligible for a credit card in the UK, you typically need to: 

You can apply for a credit card online, either through the provider’s own site or through a comparison site. Alternatively, some providers allow you to apply in branch or over the phone. You usually need to provide your personal details and information regarding your income and outgoings. Sometimes you’ll need to share details about your UK bank or building society account.

If the option is available, it could be a good idea to use an eligibility checker before applying. This is a ‘soft search’ to see how likely you are to be accepted for the card. This search doesn’t leave a trace on your credit report.

Even if you don’t use an eligibility checker, you should always check the eligibility criteria before applying for a card. Some card providers have a minimum income requirement or prefer applicants to meet a certain credit score threshold. If your application is rejected, this can negatively impact your credit score, so it is worth checking you are eligible before applying for a card.

Finally, not all applicants are guaranteed the promotional offer. Lenders are required to give the headline rate to 51% of applicants, but the remaining 49% may be offered a different rate or interest-free period. This will depend on factors such as your credit history and personal financial circumstances.

How can you choose the best credit card for you?

There are so many credit cards available that it can be difficult to know which one is best for you. Ultimately, the right card for you is the one that most closely matches your needs, habits and patterns of use. These three steps can help you identify the best card for you.

1. Determine how you’ll use the card

For example, are you planning to make a large purchase and need several months to pay it off? In this case, you could go for a card with a 0% introductory rate. Perhaps you’d like to transfer a balance from a card with a higher interest rate. In this case, a 0% balance transfer card would be the best option.

2. Make a plan for how you’ll repay what you owe

If you plan to pay your balance in full each month, then a card’s interest rate is of less concern. In this case, you’ll want a card with a longer grace period and no annual fee. If you don’t intend to pay off the balance each month, look for a card with a low interest rate.

3. List the benefits that are important to you

Common rewards and perks offered by credit cards include cashback, air miles and discounts on products. Decide which of these perks are most important to you and look for a card that offers the best mix. Keep in mind, however, that some of these perks might come at a cost. This is usually in the form of a high annual fee, so make sure the benefits outweighs the cost.

The Motley Fool’s top credit cards

Once you know what type of card you want, you can start shopping around and comparing cards. Here at The Motley Fool, we have compared credit cards across many different areas and focused on the key features and benefits that are likely to matter the most when you’re choosing a new card.

You can explore our top picks in each category, taking into account the length of any interest-free periods, the regular APR, cashback offers, loyalty points and much more!

To see our top picks for credit cards, check out our top-rated credit cards in the UK.

Still have questions?

If you didn’t find everything you were looking for on this page, we have other ways to help:

Frequently Asked Questions

What is the best credit card available?

The ‘best’ credit card available will differ from person to person. You can start by looking at our top-rated credit cards to see which card might be a good fit for your situation.

What is a credit card?

A credit card is a payment card that includes a credit agreement with the card issuer. Unlike a debit card, which directly debits the bank account it is linked to, a credit card builds a debt balance as you spend.

This balance can (and, ideally, should) be paid off in full at the end of each month to avoid incurring any interest charges. However, you can pay less than the full balance. If you do, you'll be charged interest on the balance.

What is a credit score?

A credit score is a number assigned to you by a credit reference agency that lets lenders know what type of borrower you are. There are four main credit reference agencies in the UK: Equifax, Experian, Transunion and Crediva. Your credit score is calculated from the following information:

  • Name and date of birth
  • Electoral roll information to confirm your current address and previous addresses
  • All loans, credit cards and mortgage accounts
  • Current account overdraft
  • Previous application searches and footprints
  • Joint accounts
  • Any missed repayments and how frequent they are
  • History of debt
  • Information about whether your identity has been used for fraud

How do credit cards work?

The bank that issues the card makes the payment to the merchant on your behalf and maintains a debt balance for you.

You have the option at the end of each month to pay off your entire balance or pay less than that and incur interest on the remaining balance. In order to attract customers, many credit card issuers attach offers to their credit cards, such as long interest-free periods or rewards for everyday spending.

What types of credit cards are there?

There are several types of credit cards, including purchase cards, balance transfer cards, money transfer cards, reward cards, cashback cards, travel cards and cards for those with bad credit.

How can I apply for a credit card?

You can typically apply for a credit card online, either through the provider’s site or through the links you see on The Motley Fool. Alternatively, for some cards, you can apply in the lender's local branch or over the phone.

To research and compare cards in every category, check out our top-rated credit cards.

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