How does a credit card work?

There are many advantages of using a credit card, but also important and potentially costly things to consider. Read this guide to learn more about credit cards, how they work and what to look out for.

What is a credit card?

How does a credit card work?

What type of credit cards are there?

Can I get a credit card?

How is interest on a credit card calculated?

What can I use a credit card for?

Can I withdraw cash from a credit card?

When do I have to pay a credit card off by?

How do I pay off a credit card?

Important things to remember

What is a credit card?

A credit card is a form of short term borrowing that allows you to spend money and pay back later, in return for a charge called interest.

Most credit cards come with a credit limit, which can range from a few hundred pounds to a few thousand. Your credit limit is the upper limit of what you can borrow on a particular card. Credit limits can vary and are typically determined by your personal and financial circumstances and requirements at the time of applying.

Keep in mind that if your credit card application is approved, you commit to an agreement with the credit card provider. This means that it is important that you manage your spending and make any payments that are due on time, as late repayments can have a negative impact on your credit rating.

Contact your credit card provider as soon as possible if you find yourself in financial difficulty. They may be able to support you with a repayment plan.

You can also get free help and advice from organisations such as Citizens Advice and StepChange.

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How does a credit card work?

When you spend on a credit card, interest is calculated on the overall balance and added as a cost of borrowing. In general, the longer it takes you to pay off your credit card, the more interest you will be charged.

However, if the total balance is paid off in full each month, no interest will be added for purchases. Managing your credit card in this way can make it an inexpensive form of short-term borrowing.

If the balance on your credit card is not paid off in full, your credit card provider will start to charge you for the money you have borrowed. How much you will be charged is determined by the rate of interest on your credit card.

Keep in mind that cash withdrawals are often charged at a higher interest rate and may attract additional fees.

Until the balance on your credit card is paid off, your credit card provider will send you a monthly statement. The statement should list your available balance, the minimum payment due and the payment due date.

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What types of credit cards are there?

There are many types of credit cards with different benefits, such as:

  • Balance transfer credit card – transfer your outstanding balance from your current credit card to a new balance transfer card and get all the benefits of the new card, usually including a lower or 0% interest rate on the transferred balance for a certain period of time (there is usually a fee to transfer the balance).
  • Cashback credit card – get money back when you use your card to make purchases
  • Fixed rate credit card – get a fixed interest rate for a certain period of time (usually 3 years), even if the Bank of England interest rate goes up during this time
  • Travel credit card – can be a cheaper way to pay when you’re abroad, whether you’re making payments or withdrawing cash at ATMs
  • Business credit card – use for your business expenses and you could get rewards for the business
  • Charge card – spend with higher credit limits but pay the full balance back each month (otherwise there could be higher interest and charges).

Read about our range of credit cards

Can I get a credit card?

Each credit card provider has different eligibility criteria. You should check all the eligibility criteria carefully to avoid your application being rejected, which could affect your credit score. You could run a free credit score check if you want to know your credit score.

For example, our eligibility criteria are that you must:

  • Be 18 or over
  • Be a UK resident
  • Earn a minimum of £10,000 per year
  • Be employed full time or part time, self-employed or retired.

And you must not:

  • Have had any Defaults, County Court Judgements (CCJs) or entered into any Individual Voluntary Arrangements (IVAs) or Trust Deeds in the past 6 years
  • Have been declared bankrupt in the past 6 years
  • Be in arrears or have missed more than 2 payments on a credit agreement in the past 6 months.

How is interest on a credit card calculated?

Credit card providers will charge interest (Annual Percentage Rate) if you carry a balance from one month to the next. This means that you will be charged interest for each month that you have an outstanding balance.

If you don’t pay off your credit card in full each month, credit card providers are likely to charge you interest from the date your transaction shows on your account. Any payments and/or refunds that have been received will also be taken into account.

Cash withdrawals however are treated differently. Unlike interest on credit card purchases, interest on cash withdrawals is usually charged as soon as you use the card to withdraw or obtain cash. This also means that cash withdrawals do not benefit from an interest free period in the way purchases may do.

Remember, if you only pay the minimum payment every month, it will take you longer to clear your balance. You will also pay more interest.

What does APR mean?

APR stands for Annual Percentage Rate. Credit card providers use this abbreviation to describe the cost, including any fees (total cost of credit), of borrowing money over a year.

You can use it to compare the cost of similar products from other lenders.

The APR will vary between different types of credit cards and providers. It is important that you are aware of this when comparing credit cards so that you can find the best one for your needs and personal circumstances.

Read our guide explaining APR

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What can I use a credit card for?

As long as you are within your credit limit, you can use your credit card to make purchases, withdraw cash or make cash-related payments, although cash related use (also known as ‘credit card cash advances’) may be charged at a higher rate of interest.

What you use your credit card for is up to you, but it is important that you keep track of your spending.

Some people may use their credit cards for smaller, regular purchases, such as paying for fuel or weekly food shops, while others may prefer to use them for larger purchases such as flights or a holiday.

Section 75 and the Consumer Credit Act

Some credit card purchases come with added legal protection. When buying items valued between £100 and £30,000, you will automatically be covered by ‘section 75’ of the Consumer Credit Act.

This means that if a company that you have bought products or services from goes into administration or if your purchase is faulty, you may be able to claim all or part of your money back from the credit card provider.

Learn more about how you are protected by section 75 of the Consumer Credit Act on the MoneyHelper website

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Can I withdraw cash from a credit card?

Yes, you can withdraw cash with a credit card, but it is likely to come with a higher interest charge and/or additional fees, which can make it expensive.

To avoid unnecessary charges, always check the cost of withdrawals with your credit card provider before withdrawing cash, both at home and abroad.

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When do I have to pay the credit card off by?

Unlike loans, credit cards usually don’t have to be paid off over a set period. However, the faster you pay your balance off, the less interest you will pay.

What does it mean to pay a credit card off ‘in full’?

Paying a credit card off ‘in full’ is the same as paying the whole (or remaining) balance. Once you have paid your card off in full, your credit card no longer has any outstanding money to pay.

What does ‘minimum payment’ mean?

The minimum payment is set by your credit card provider and is the minimum monthly amount that you have to pay if you have an outstanding balance.

Keep in mind that if you only pay the minimum payment every month, a credit card can be an expensive way to borrow.

Late payments, or not paying at all, is likely to damage your credit score, as well as result in additional charges.

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How do I pay off a credit card?

At the end of each month, your credit card provider will send you a statement.

Most credit cards will allow you to either:

  • Pay it off in full (clear the balance)
  • Pay the monthly minimum amount set by the provider, or
  • Pay an amount chosen by you (that is no less than the monthly minimum payment)

Ways to pay vary between credit card providers, but often include paying through online banking, via their app, over the phone or by setting up a direct debit.

Tip: If you set up a direct debit, your credit card will be paid automatically. This reduces the risk of having to pay additional fees and charges if your payment ever happens to be late.

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Important things to remember

There are a few important things to consider when managing or applying for a credit card:

  • Submitting multiple applications for credit cards can have a negative effect on your credit score.
  • There may be other forms of borrowing that are better suited to your needs, such as a personal loan or an arranged overdraft.
  • Always pay your credit card on time. In addition to late fees, paying late is also likely to affect your credit score and increase your overall debt.

If you need help with your finances, there are many organisations that can help. MoneyHelper and The Citizens Advice Service offer free and confidential advice on money problems.

You can also visit our financial support page.

See our credit cards.

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