How do credit cards work?
Credit cards explained
With the multitude of different types of credit card available, you could be forgiven for wondering which is the right one for you.
This guide explains balance transfers, money transfers, cashback cards and much more to help you navigate the credit card maze and avoid the hidden nasties of what can be dangerous cards if used wrongly.
In this guide
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What is a credit card?
Firstly, the term 'credit card' is completely misleading as these are 'debt cards' as they allow you to borrow on them - money you need to pay back, ie, debt.
As 'credit card' is such a common term we will continue to use it here for clarity, but be aware that debt is like fire - used right it's a useful tool but used wrongly you'll get burnt.
All cards come with a credit limit, which is the maximum amount you can borrow. Lenders decide how much the limit is based on a number of factors including your income, credit score and other debt repayments. These factors also determine if you are even accepted in the first place.
If you borrow money on a credit card, you'll be charged a rate of interest, calculated as an APR (annual percentage rate). However, most cards waive interest on spending (not cash withdrawals) if you pay the money back in full by the due date on your monthly statement.
If you do choose to apply for a card, remember to use our credit card eligibility calculator first so you can check your chances of acceptance without affecting your credit score.
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How do balance transfer credit cards work?
A balance transfer is when you get a new card that repays debts on other credit or store cards for you, so you owe it instead - often at 0%. This means you'll be debt-free quicker as repayments will go towards clearing the actual debt, not interest.
The longer the 0% period, the longer you have to clear the debt without worrying about paying interest. The longest deals typically have a one-off fee as a percentage of the amount borrowed, yet there are other cards - albeit with shorter 0% periods - where you can shift the debt for free.
To be sure, pick the card with the lowest fee in the time you're sure you can repay. If unsure go longer for safety, even if there's a fee. Importantly, they're NOT for new borrowing as it isn't usually at the cheap rate.
Who are they best for? Those paying interest on credit or store cards.
This helpful little video gives you the balance transfer lowdown...
How do 0% spending credit cards work?
These are fairly simple as you can make purchases on the card and pay no interest for a set period, useful if you want to spread the cost of a big, planned purchase.
Importantly though, you must pay at least the minimum each month to keep the 0% period. Used correctly, these cards are cheaper than loans (though you may not always get a big enough credit limit to cover what you want to buy) - yet get it wrong and you could be stuck in debt for years.
Who are they best for? Those who want to spread the cost of a big, planned purchase.
How do travel credit cards work?
Specialist travel credit cards do not charge the typical 3%-ish fee on spending abroad, so £100-worth of euros actually costs you £100. This makes them, in most cases, the cheapest way to spend abroad as you get the same, near-perfect rates the banks get.
Do watch out for charges on cash withdrawals as some hit you with a fee and/or daily interest on cash till it's paid off. Therefore, they're cheapest for spending, rather than taking out cash. Always repay IN FULL to avoid interest which will wipe the gain.
Who are they best for? Those who travel overseas, or spend a lot on overseas websites, who can repay in full each month.
How do money transfer credit cards work?
A few specialist cards offer a 'money transfer' that lets you pay cash into your bank for a small fee. You then owe the card instead, often at 0%.
If you’re looking to borrow less than about £3,000, money transfer cards often beat loans - as loan rates are high at that amount.
Crucially, to get the cheap rate, never just take cash from an ATM, ask the card firm to "do a money transfer to my current account".
Who are they best for? Those paying interest on an existing loan or overdraft, or where you need to borrow money but the firm you're paying doesn't take credit card as you can use the new money in your bank to pay. If you want to pay off debt on a credit a store card, a balance transfer (above) is better.
How do all-rounder credit cards work?
Most credit card deals either allow you to shift debt to them cheaply or spend on them cheaply. But an all-rounder card lets you do both, meaning one fewer application hitting your credit file, protecting your creditworthiness.
While the top deals on these cards rarely knock the specialised balance transfer or spending cards off their top spots in that department, they're worth checking out if you need both functions.
Who are they best for? Those with existing debt, who want to transfer a balance and spend at 0% on the same card.
How do 'bad credit' credit cards work?
Bad credit credit cards are designed for those with little or poor credit history. When used for normal spending and paid off IN FULL every month, they can help build (or rebuild) your credit score to hopefully help you get better deals in the future.
In fact, as the APR tends to be hideously high, it is vital for your finances today that you repay IN FULL every month to avoid the horrid interest.
Some also come with 0% balance transfer or spending lengths but often the promotional rate is for far fewer months than cards for good credit scorers. If you don't know your credit score, it's worth joining our free MSE Credit Club to find out and get tips to boost it.
Who are they best for? Those who have been rejected for other credit cards because of a poor credit score, and to (re)build your credit score.
How do cashback or reward credit cards work?
Some cards pay you to spend on them. Some people think this is too good to be true but believe us when we say that if you play your cards right, they do exactly what they say on the tin.
You can be paid in cash, usually as a credit on your account at a set point in the year, or in vouchers or airline points.
However, you need to repay them IN FULL every month or interest charged will dwarf the gains.
Who are they best for? Those who pay their card in full every month and want to get paid to spend.
Credit card golden rules
Importantly, always follow the golden rules for each card type explained in the many guides we link to. But if you read nothing else, this means:
- At worst, always making at least the minimum payment or you can lose any special deals and get clobbered by additional charges.
- If you've a 0% deal always aim to clear the card in full by the end of the 0% period (or do a balance transfer) or you'll pay the far higher representative APR interest.
- If you use a card for new borrowing, remember it's a debt so NEVER see it as an excuse to overspend - you must pay at least the minimum each month to keep the 0% period.
- With a card that pays you to spend, always pay the full balance to avoid interest which can dwarf any gains.