What is a Credit Card?

How credit cards work

It is important to understand how credit cards work if you’re planning on using one. In a nutshell, you are borrowing money from your card provider to make a payment when you make a purchase using a credit card.

Typically, there’s a minimum monthly amount you need to pay back, which may include any interest and charges added to the amount that you owe.

However, credit cards usually have an interest-free period of up to 56 days after you make a purchase, and some providers also offer interest-free introductory deals, so if you pay your bill on time and in full each month you can avoid paying interest altogether.

Understanding credit cards

Before you apply for a credit card and start using it, make sure you understand the details of what you’re signing up for, so you know exactly what to expect when making payments and incurring interest and other charges.

Annual percentage rate (APR): This is the interest rate you’ll be charged over a year.
Credit limit: This is the maximum amount of money you can spend on your credit card.
Minimum payment: This is the minimum amount you need to pay off your credit card balance each month, including interest and any other charges. Paying more than the minimum payment when possible will help you to clear your debt more quickly.
Statement balance: This shows you how much you have spent on your credit card each month, including any interest and fees applied since your last payment.
Payment date: This is the date that your credit card provider needs to receive your payment. Aim to pay a few days in advance of this date to give your payment time to be processed and avoid late payment fees.

Different types of credit cards

There are several different types of credit cards, so consider when, where and how you may want to use it before choosing the one that best suits your needs.

Balance transfer cards: If you already have a credit card, you may save money on interest by transferring the balance to a 0% interest credit card or low-interest balance transfer card. The interest-free or low-interest offer is usually only available for a set period of time, but this can last for up to 30 months. You can expect to pay a small fee when you transfer your balance, and you will need a healthy credit score to be eligible for this type of card.

Reward cards: This type of card rewards you every time you use it to make a purchase. Offers vary between providers, but typically include cashback, vouchers or air miles. Reward cards often have a higher interest rate and you can be charged more in interest than you earn in rewards if you don’t clear your balance in full each month.

Purchase cards: If you’re planning an expensive purchase, this type of credit card can be used to spread the cost. These typically offer 0% interest for a set period of time, which could be anything from a couple of months to over a year. You won’t pay any interest if you clear the balance in full before the promotional period ends. After that, you will pay the standard interest rate set by the card issuer.

Credit builder cards: This type of credit card is aimed at people who find it hard to get credit, perhaps because they have a low income, a poor credit score, they are new to the UK or have just turned 18. Credit builder cards usually have a low credit limit and higher interest rates, so it’s best to keep spending to a minimum and pay off the balance in full each month to help build a positive credit history.

Travel credit cards: It can be expensive to use many credit or debit cards overseas, but travel credit cards don’t charge a fee for making purchases or withdrawing cash in another country. They tend to offer good exchange rates, although interest rates can be higher. For this reason they’re best saved for holidays, or spending on foreign websites. Aim to pay them off quickly to avoid being charged interest.

Money transfer credit cards: These work in a similar way to balance transfer cards, but you can transfer money straight into your bank account to clear an overdraft or benefit from an interest-free loan. Money transfer credit cards typically offer a 0% interest introductory rate, which means you can save on interest fees provided you pay off your balance before the introductory period ends.

What are the pros and cons of using a credit card?

There are several advantages and disadvantages of using a credit card to pay for goods and services.

Advantages of using a credit card

Spreading the cost of purchases: If you need to pay for an expensive item, using a credit card means you can spread the cost over several months. However, you may pay more in interest on top of the amount you spend unless your card offers an interest-free introductory period.
Payment protection: When you spend between £100 and £30,000 using a credit card, you’re covered under Section 75 of the Consumer Credit Act 1974. This means that you won’t be left out of pocket if there’s an issue with the item you bought, if it isn’t delivered, or if the company selling it goes out of business.
Consolidating debts: If you are paying off other credit cards that have high interest rates, it can work out cheaper to transfer your existing debt to a low interest rate credit card. Some providers offer interest-free deals to new customers, which allows you to reduce your debt without paying any additional interest on the amount you owe for a set period of time.
Building your credit score: If you use your credit card responsibly, make regular payments on time and don’t go over your limit, this can help to improve your credit score. If you need to build or repair your credit score, a credit builder card could help. As these tend to have lower spending limits and higher interest rates, it’s best to only use them to spend a small amount each month, and then pay off your balance in full. This can help you build a history of managing your credit responsibly.
Loyalty points and rewards: Some credit cards offer rewards and loyalty programmes where you can earn points with purchases. Offers vary between providers, but can include cashback schemes, vouchers or air miles.
They are easy to carry and use: Credit cards are easy to carry, and can usually be added to a digital wallet. They can be quickly and easily cancelled if they are lost, stolen or used fraudulently, and you’re more likely to get the money back – which isn’t the case with cash.

Disadvantages of using a credit card

You’ll pay interest on purchases: Unless you pay your bill in full each month, or you have an interest-free introductory offer, you will pay interest on everything you spend. This can quickly add up, making it an expensive way to borrow money.
You could pay extra fees: Most credit card providers will charge a fee if you withdraw cash, and you’ll also be charged interest from the date you make the withdrawal – often at a higher rate than on credit card purchases. If you fail to make a payment on time, most providers will charge a late payment fee of up to £12, along with interest. You will be charged an additional fee if you go over your credit limit, and you may incur charges if you use your card overseas.
There’s a risk of persistent debt: If you only make the minimum payment each month, you could end up in ‘persistent debt’, which means you’re paying more to cover interest and fees than you are towards paying off your credit card balance. If you are in this situation it’s important to discuss manageable repayment options with your credit card provider.
Your credit score could suffer: If you miss payments, exceed your credit limit, or consistently use more than 30% of your limit, this can damage your credit score and make it harder to borrow money, or benefit from the best interest rates, in future.

How to apply for a credit card

To be eligible to apply for a credit card in the UK you need to be a UK resident and aged 18 or over. Some providers will also want to ensure you earn a certain amount of money, or are in full-time employment.

Generally speaking, you can apply for a credit card online by filling out some basic information, such as your name, date of birth and address, along with details of any other addresses for the last three years. You’ll also need to supply details of your income and employment, and you may be required to show some identification, such as a passport, driving licence, bank statement or utility bill. Alternatively, you may be able to apply at the branch of the relevant bank or complete a form and send it back in the post.

Many providers offer a pre-application eligibility checker which indicates whether your application is likely to be successful. Unlike a full credit card application, this will only run a ‘soft check’ that won’t show up on your credit file, and will not only tell you if you’re likely to be accepted but will also give you an idea of the credit limit and APR you would be offered.

Once your application is submitted, the provider will run a credit check, which will show up on your credit report and might affect your credit score. If you make several applications, or if one or more of them are refused, this could affect your chances of getting credit in the future as it suggests that you’re struggling financially. For this reason, it’s important to take your time deciding on the best card for your needs, and not to apply unless you’re confident that you will be accepted.

Credit cards and credit scores

When you apply for a credit card, lenders will look at the information on your application form and check your credit score. This information gives lenders an idea of how likely it is you will pay back any money that you borrow.

Your credit score shows lenders a range of information about your finances over a period of up to six years. As well as confirming your address, whether or not you’re registered to vote, and the details of people you have a financial connection with (such as a joint bank account or mortgage), your credit report includes:

When you’ve borrowed money and how often you have applied for credit
How much credit you’re using
Whether you have missed payments or paid on time
If you have been declared bankrupt, had County Court Judgements (CCJs) against you, or have an Individual Voluntary Agreement (IVA) to pay back outstanding debts.

When you have a higher credit score, your application for a credit card is more likely to be accepted, and there’s a greater chance that you will be offered the best rates. If you have a poor credit score, you are more likely to struggle to get credit cards or loans or access the best rates.

Equifax, Experian and TransUnion are the three main credit reference agencies in the UK. When you apply for credit, lenders will ask one, two or all of them for your credit reference. For this reason, it’s important to check your credit report to make sure that the information they hold about you is correct and up to date.

You can check your credit report for free with Experian or Equifax, although Equifax charges a monthly subscription fee after a 30-day trial period. However, you can also use the ClearScore app to get free access to your Equifax credit score which updates every week. You can use Credit Karma to get free access to your TransUnion credit score.

Managing credit card debt

If you’re already struggling financially, applying for a new credit card could make your situation worse. Before you apply, consider seeking free debt help from charities such as:

There is a range of help available, including the ‘Breathing Space’ scheme, which can give people who live in England and Wales a break from interest and charges while they get their finances back on track. In Scotland there’s a similar scheme called the Debt Arrangement Scheme. There are plans to establish a Debt Respite Scheme in Northern Ireland following a public consultation, but it isn’t yet available.

» MORE: Compare credit cards

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How credit cards work

Understanding credit cards

Different types of credit cards