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How do credit cards work?

A guide to understanding credit cards – and why they can be useful

When it comes to managing your finances, being able to borrow money using a credit card could be extremely helpful. But before deciding whether they are right for you, it’s sensible to find out a little bit more about them. This is where our straightforward guide can help

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Credit cards offer flexibility with our finances. Whether it’s spreading the cost of purchases, helping to pay off debt, building up our credit score, or even earning cashback and rewards, they can be a great option.

However, given the many choices available and the potential for costly mistakes if you don’t use them smartly, there are a few things to consider before you apply.

How do credit cards work?

Put simply, credit cards allow you to borrow and spend money you don’t yet have, with the credit card provider trusting you will pay back what’s owed within a set period.

The provider, usually a bank or building society, sets the credit limit and interest rate, and as long as you clear your balance each month you should have no interest to pay.

Your monthly statement will detail how much you owe and have to pay by when. If you only make the minimum payment, you will be charged an interest rate depending on what was agreed when you applied for the card.

If you forget to pay on time you will also be charged a late payment fee – which is where it can start getting expensive.

Why do people get credit cards?

There are a number of advantages to having a credit card and different cards are designed for different needs.  Ways they can help include:

  • Spreading the cost of a big-one off/emergency purchase
  • Moving existing debt to give you time to pay it off interest-free
  • Offering protection when buying goods and services
  • Building or repairing your credit score
  • Earning cashback or rewards
  • Spending fee-free at lower exchange rates when overseas

Read more with our guide to Why do I need a credit card?

Why do banks offer credit cards?

Of course, banks aren’t just dishing out credit cards because they want to be nice to their customers – they do it to earn a profit.

When banks lend through a credit card, they know that a percentage of customers will either forget or be unable to pay off their balance in full at the end of the month.

This allows them to charge interest and earn revenue that outweighs any cashback or rewards they give to other customers, or fraudulent payments they have to cover – if your card details are stolen, for example.

The good news is that if you use your credit card wisely, you can benefit without financial cost.

How do the different types of credit card work?

With various types of credit cards available, the right option to pick depends on what you want from the card, your spending habits and your credit history. Here’s how each type of card works:

0% purchase cards: As its name suggests, banks attract customers by offering  0% purchase cards that won’t charge any interest on goods for a set period. It effectively means you can buy an item now and pay later (as long as it’s within the 0% period) – or spread the cost over time – without paying more. If you need to buy a bigger item or if you purchase items online regularly, this could be a good option for you.

0% balance transfer cards: Instead of offering interest-free purchases, a 0% balance transfer card allows you to transfer debt from an existing card or loan with a high rate of interest onto another without having to pay any interest on the debt. There is a fee for this but it’s likely to be less than the interest on your former card. The key is to only use this type of card for moving a debt from elsewhere – not for extra spending – and try to clear the debt before the 0% period runs out. Or you can end up paying more in interest.

Balance transfer and purchase cards: Some people don’t want to switch cards frequently, so maybe a card that offers both a low lifetime rate and no balance transfer-interest is more appropriate. A balance transfer and purchase card might be the best of both worlds – you could get 0% interest on both transfers and purchases for a certain timeframe.

0% money transfer cards: Allow you to move cash from a card to your bank account to clear your overdraft or give yourself a 0% cash loan for a fixed period. There is a one-off fee and when applying make sure you ask the lender to transfer the credit amount into your bank – don’t withdraw it as cash.

Cashback and rewards cards: Cards that reward spending, such as cashback cards or rewards cards, offer air miles, store credit and more when you use them. Banks offer these incentives as a way of gaining your loyalty in the hope that they’ll make money off you through interest repayments or fees – but stay on top of your finances and you can make the cards work for you without penalty.

Credit builder cards: Applicants new to borrowing or with a low credit score will often find it difficult to get credit, so banks and card providers offer so-called credit builder cards. Often these have lower credit limits and higher interest rates, but they allow you to build up trust with providers that you can responsibly borrow. The best way to build your credit score is to only spend a portion of the credit available to you every month and then pay off the balance in full. As your credit rating improves, so does the range of credit card options available.

Overseas spending credit cards: Overseas spending cards charge no or low fees for use abroad, which makes them more suitable for frequent travellers. If you travel a lot for work, or just enjoy a holiday, then an could be the right way to go.

Still not sure? Use our credit card decision tree to find the right card for your circumstances.

How do other credit card features work?

  • A big advantage is the credit card protection offered by Section 75 of the Consumer Credit Act. The act says that by law lenders are responsible for the credit agreements between traders and individuals. This means if you buy something that costs between £100 and £30,000, and it is either faulty or the company you bought the item from goes bust, then you can get your money back from the card issuer. While you might also get some protection when paying by debit card through what is known as ‘chargeback’, this is a voluntary scheme and doesn’t afford the same legal protection.
  • As with a debit card, the Consumer Credit Act means that by law credit card providers will reimburse you for fraudulent activity on your account if your card is stolen provided you have taken all reasonable precautions and act promptly when you realise something is amiss. Read our guide to credit card security.
  • Credit cards are widely accepted by retailers the world over – making them very convenient ways to spend. Contactless payments can be made, not just through cards, but your smartphone and an increasing range of wearables, such as smart watches.
  • Smartphone apps and websites allow you to track your balance at any time. Automatic alerts will notify you when you are close to your credit limit or payment date. Direct debits can also be set up to clear your minimum payment or full balance, so you are never charged a late payment fee.

What do I need to watch out for with credit cards?

Credit cards need to be used smartly. That means staying on top of what you owe and making payments on time, and avoiding these other missteps:

Pay more than the minimum: This will clear your balance quicker and significantly reduce the interest you pay over that time. For example, if you spend £1,000 on a credit card with an APR of 18.1% and repay the minimum each month (2.5% of the outstanding balance or £5, whichever is greater), it will take you 16 years and 11 months to clear the balance, paying £1,113.44 in interest – more than doubling the cost of the original purchase.

Pay your balance off in full each month: If you can, clear your balance in full every month. That way, you can ignore the interest rate charged and take advantage of the cashback and reward cards on the market to reduce your costs.

Be careful with your applications: If you make a credit card application which is rejected, it can have a negative impact on your credit score. Making too many applications in a short space of time can also have an effect. Use the MoneySuperMarket Eligibility Checker instead, to scour the market for the best deals for your circumstances and requirements without taking a hit to your score.

Use a credit card to improve your credit rating: Although having too much debt can negatively affect your credit score, having no credit history at all can do the same. Fortunately, there are credit builder cards aimed at people looking to improve their credit ratings.

Make your payments on time: It’s important to always make your credit card payments on time. If you miss a payment you’ll be charged a fee of at least £12, which may also leave a mark on your credit score, making it more difficult to borrow in the future. You may lose access to promotional offers too, such as 0% on balance transfers or purchases.

Set up a direct debit: Even with the best intentions to pay your credit card bill by the due date, we all make mistakes and it can be easy to slip up. To avoid missing a payment, it’s sensible to set up a direct debit to ensure you pay off at least the minimum amount each month.

Get a cashback or reward card: If you pay off your bill in full every month, a cashback credit card can be a great way to get more for your money. It will return a percentage of what you spend, either as a cash payment or a reduction in your bill.

Avoid overseas fees: Most debit cards charge you a foreign loading fee of between 2.5% and 3.0% if you use them to make purchases while abroad, and while the majority of credit cards do too, there are some exceptions. A travel credit card is a wise bet if you want to avoid the usual costs of overseas spending.

Can I get a credit card?

Whether you are eligible for a credit card will depend on your credit rating.

Whenever you apply for credit, be it a card or a loan, the provider will carry out a credit check – this is to find out whether you’re able to pay back the credit. Generally speaking, the most competitive offers are reserved for consumers with a good credit score.

If you have a poor credit history, your application could be turned down. Alternatively, the company may offer you less favourable rates instead of the advertised interest rates.

Making multiple rejected applications for credit cards can damage your credit score, but the problem is that you don’t know whether you’ll be turned down until you apply.

Read our guide to improving your credit score here.

Compare credit cards

With so many types of cards and providers out there, choosing the correct card can be overwhelming, but MoneySuperMarket can help you find the right card for you.

Whether you want a cashback card, a card for travelling the world, or one for bad credit, we compare deals from the UK’s leading card providers and banks.

To find out which cards you'll be accepted for without affecting your credit score, try our quick and easy eligibility checker.

You’ll see your personalised chance of approval for all credit cards, so you can easily compare your options.

With a pre-approved credit card, the deal you see is what you get. The interest rate and interest-free period are all confirmed – the only thing not guaranteed is your credit limit.


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