Brown leather wallet stuffed with credit cards

You hear the horror stories of people unwittingly racking up mountains of crippling debt on credit cards. So whilst there may be a place for them at certain times, they can also wreak havoc on your financial health unless you understand the basics of how they work.

Credit Card debt in the UK stands at an eye-watering £70 Billion

Guardian 2018

What is a credit card?

In their simplest form, credit cards provide you with access to a pre-approved loan from the bank or credit card issuer.

Listen up. This is important. Credit cards are pre-approved loans! They are not free money. Banks and lenders are in the business of making money by lending it to you and charging you interest for the privilege.

  • Debit cards only allow you to spend your money that is in your account.
  • Credit cards let you spend up to the amount you are pre-approved to borrow.

People spend 38% more on a single credit card transaction that on debit cards.

What is a credit search?

When applying for a credit card, you will need to fill out your personal details. From there, the lender will gather all the data on your ‘credit file’ from one the UK credit reference agencies. This referred to as a ‘hard search’. and looks at:

  • Homeownership
  • What other debts you have
  • Files from the credit reference agencies
  • electoral roll information
  • Available credit you are not using
  • Credit and repayment history including missed payments and CCJs
  • Income

The result is that the lender now has a ‘risk profile’ of you and a predictor of how much money the lender will make from you now and in the future. This is known as a credit score. From there, they will decide how much they are prepared to lend you. This is your ‘credit limit‘.

The approval process is usually done instantly online. The card is then posted to you a few days later. Your PIN (Personal Identity Number) will be sent separately for security purposes.

Pro Tip – check out this article to help improve your credit score

What is a credit score?

A credit score is a a tool used by lenders to assess and predict your borrowing and sending habits.

  • Uses informaiton within the hard search
  • A credit score is a three-digit number
  • There is no universal credit score system.
  • A credit score helps the lender assess their risk and how much money they will make from you
  • Lenders use information on you held by the three UK credit reference agencies: Equifax, Experian and Callcredit
  • Will heavily influence your credit limit and interest rate

How much can I borrow on my credit card?

Your credit score is a major influence in the credit limit you’re offered.

A low credit score represents a higher risk and lower income to the lender. Therefore, they will be given a lower credit limit and/or high-interest charges.

Somewhat ironically, even though you may be squeaky clean, have a good income and never had a credit card before, you may also be offered a low credit limit. At least to start with. The lender doesn’t have any real data on which to base t’s decision. For this reason, it’s a good idea to start building a (healthy) credit history early.

As time goes on and you demonstrate you regularly meet your payments and never miss one, your lender may increase your limit in future.

60% of UK adults hold at least one credit card product

Financial Conduct Authority

Can I go over my credit limit?

You can, but doing so shows you are a risk to the lender and has pretty dire consequences, including:

  • Losing an introductory rate such as 0%
  • Increase in interest rates
  • A black mark against your credit score
  • Credit limit reduction

Each month you will receive a statement from your credit card company. It will show what you have borrowed and the minimum amount to pay back. Everything you don’t pay back will incur interest.

Can I check I’ll be accepted for a credit card before applying?

Yes, and you should.

Applying for a Credit Card and getting rejected can seriously damage your credit score. In addition, having multiple hard searches on your record, which last about six months, also has a negative impact.

Therefore, to reduce the chance of reducing your Credit Score you can use a credit card eligibility checker. This will indicate whether you will be approved before officially applying.

Want to know how to manage credit cards well?

Why are credit card minimum payments so low?

Remember, there is no such thing as free money. These lenders are in the very lucrative business of earning interest from you. The longer you owe them the debt, the more money they make from you in interest. You become a cash machine that just keeps on giving.

Credit cards are BIG business

To make that happen, the minimum payments are there to keep you hooked. They provide a false sense of affordability.

Lenders are now obligated to make you aware on your statements that by only paying the minimum payment, it costs you significantly more money over the long term. BUt they know that literally no-one reads this. To hell with the small print, just give me that juicy credit for the good times, amiright?

The credit card you choose will differ depending on your requirements. Check out this guide on choosing the right one.

How is credit card interest calculated?

The interest rate is the amount of money you are charged each month for the cost of the loan and is based on a percentage.

For example, an interest rate of 20% on a £1,000 balance would mean the cost of borrowing is £200. Generally, shoot for the lowest interest rate you can.

If you miss payments or have a poor credit score, lenders may increase the interest charges as they perceive a greater risk.

What does all the credit card jargon mean?

Here are some of the words you see regularly used. It’s important to know what they mean.

  • Annual Fee – some credit card providers charge an annual fee for the use of their card. It’s best to avoid these.
  • Credit Limit – represents the maximum amount of money (ie, credit) you can spend on your credit card.
  • Balance – is the total amount of debt outstanding – this is the amount you will be paying interest on if you do not pay off your card.
  • Interest Rate – the amount of money you are charged each month for the cost of the loan and is based on a percentage.
  • APR – Annual Percentage Rate is the interest rate for the whole year. It is an industry standard that allows you to easily compare products. The lower the APR, the lower your interest repayments.  
  • Minimum Payment – is the minimum amount you will need to pay each month and usually taken via direct debit.
  • Balance transfer – is when you move the balance from one card to another, usually to take advantage of an initial 0% interest free period.
  • Cash advance – you can take out cash on your credit card from a cash machine. But beware, you’ll be charged a lot more interest. Think a crippling 26% plus.

Pro Tip – looking for the best current deals on Credit Cards? Check out Martin Lewis’ comparison website.

What is credit card protection?

Credit cards offer protection on purchases between £100 and £30,000. This can mean large ticket items like TVs, appliances or holidays can be purchased via credit card. Then if anything goes wrong (ie the product doesn’t turn up or your holiday operator goes bust), the credit card company will take measures to recover the money on your behalf.

This article shows a great example of how a Southern Rail season ticket holder successfully claimed a partial refund of his ticket via his credit card company, due to delays and poor service.

Credit cards can also sometimes be considered as an alternative to taking out Extended Warranties on appliances. Check out this article to find out more.

If something goes wrong with a purchase made on your credit card, call your lender and ask for assistance.

Do I need a credit card?

We’d like to say no, no you really don’t. However, the reality is that in the world we live in today, having a healthy credit history is increasingly important.

There may be times when having one to hand is worth it, if:

  • You are on top of your personal finance game
  • You have a stocked emergency fund of at least £1,000
  • Have the discipline to pay the balance in full each month

Check out this article for the six ways a credit card can be useful.

And if you’re going to bite the bullet, you need to make real sure you manage it well. See our article on how to manage credit cards well.

How can I get help with credit card debt?

Credit Card debt in the UK stands at an eye-watering £70 Billion. If you are struggling to pay back debt, get help. You can start here with Step Change, a UK based debt advice charity.

Credit cards can rack up serious amounts of debt and scarily quickly. It is important to understand how they work. If they’re managed well and you’re disciplined, then they can have their place.

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Credit Cards basics – this is what you need to know
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