Finance > Credit Cards
What Is a Credit Card?
Put simply, a credit card is a way of borrowing money. Your credit card provider will loan you money, which ultimately you have to pay back plus any agreed charges.
In This Article
Key Terms:
- Credit Score – A credit score is a measure that gives an indication of an individual’s reliability surrounding debt. In other words, it is how worthy you are of borrowing money.
- Interest – The cost of borrowing from the credit card supplier
- Debt – This is money that you owe
- Credit Limit – The maximum amount that the lender has allowed you to borrow
- Minimum Payment – The minimum amount you have to pay back to avoid additional charges
What is a Credit Card?
A credit card is a form of borrowing money to pay for goods and services. You borrow this money with the agreement to pay it back, plus any charges incurred.
Advantages:
- Extra protection on purchases if something goes wrong
- If used correctly, it can be a cheap way to borrow
- If you are a trustworthy borrower, it can boost your credit score
Disadvantages:
- You can spend more than you can afford, leading to repayment issues
- If you miss repayments, the interest owed can quickly spiral
- It can ruin your credit score if not managed correctly
Cost of Borrowing (APR)
When comparing credit cards, the amount you are charged to borrow the money is likely to play a part in which card you choose. As such, the figure you should be paying attention to is known as the Annual Percentage Rate (APR) – this is your cost of borrowing.
APR is calculated based on: the interest rate charged + associated fees, e.g. annual fee
Due to APR taking into account both interest rate and associated fees, it gives you the cost of debt over a year. For this reason, it is the figure you should use to compare the annual cost of borrowing between lenders. In addition, you may want to consider other factors such as rewards and cashback associated with the card.
Note: the lender must display the APR, so keep looking for it!
Representative vs Personal APR
Representative APR is the rate that at least 51% of successful applicants must get (usually the advertised rate). The other 49% can get a different rate, which is generally higher. The rate you are actually offered based on your personal circumstances is called your Personal APR.
How to Read a Credit Card Statement:
When you get a credit card statement, it will show you four key things:
Statement Balance: £500
Minimum Payment: £15
Due Date: 17th February 2022
Statement Date: 21st January 2022
What do these mean?
- Statement Balance
Assuming your statement balance is starting at £0.00, this is the full amount you have spent within this statement’s timeframe. Therefore, this is the amount you need to pay back before the due date to avoid paying interest.
- Minimum Payment
The minimum amount you have to pay back each month. The amount is calculated as a percentage of the statement balance, or in some cases, it may be a flat fee. If you opt only to pay the minimum before the due date, you may be charged interest on your remaining statement balance until this is repaid.
In the above example, the minimum repayment is 3% of the statement balance.
3% of £500 = £15
- Due Date
This is the latest date you must pay your whole statement balance to avoid paying any interest. If you’re prone to forgetting, you may want to set up a direct debit to avoid missing payments.
- Statement Date
This is the last day of this statement’s billing cycle. After this date, any money spent on your credit card will be counted on the following month’s statement.
Top Tip:
To avoid paying any interest, always pay your credit card off in full before the due date!
Applying for a Credit Card
When you apply for a credit card, it is down to the lender’s discretion as to whether they give you one and, if so, what your credit limit will be.
Several factors can influence whether your application is successful, such as your credit history, employment status, and income. It is advised to use a free eligibility checker before applying properly for a card – a declined application can have negative implications for future applications.
There are many types of credit cards to choose from. You can choose to receive rewards, get 0% interest for an agreed time period and even improve your credit score. Before sending applications, it’s worth looking around and finding one that fits your requirements.
Best Practice
- Pay off your card before the due date
When you spend money on your credit card, you are charged an interest rate. However, this cost is usually waived if you pay back the full amount before the due date.
- If you can’t pay it off in full, pay off as much as you can, above the minimum payment
If an extravagant purchase sets you back more than you can afford to pay back, then make sure you pay back as much as you can, above the monthly minimum, to reduce accrued interest.
- Don’t use your card to withdraw cash
Avoid using your credit card to draw out cash as much as possible. Cash withdrawals on credit cards are likely to incur additional charges. For more, see our article on credit card interest rates below.
- Find a card that suits you – enjoy the benefits!
If you travel a lot and air miles would be useful to you, or you love shopping at a specific store, see if they offer a credit card and reap some rewards suited to you.
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