How do credit cards work???
In this guide we will look at the most common questions people ask about credit cards, we will answere the “how do credit cards work” question and then introduce you to the different kinds of credit cards available so you are better equipped to make a great financial decision.
How do credit cards work???
Credit cards work just like loans but unlike loans, credit cards provide credit for an indefinite time. This is also known as revolving credit.This means credit that is automatically renewed(offered) when debts are paid off.
Credit cards work by giving you access to a fixed amount of money(Your credit limit). You can spend this money as you like but you will need to pay some or all of it(Your monthly minimum payment) back on its monthly due date to avoid being charged interest. If you fail to make this minimum payment on your credit card you will be charged fees.
Let’s take a deeper dive into a few terms associated with credit cards which you will need to know such as credit card limits, minimum payments and much more.
Credit card limits?
What are credit card limits?
Credit cards work by providing you with a credit card limit, this is the maximum your credit provider has offered you in credit. This is the maximum you should be able to spend. Some credit card providers do let you spend over this limit but they will charge you a fee for doing so.They may also restrict your spending until you clear the balance which went over your credit card limit.
You will usually only know how much credit limit you will get after you have applied for a credit card and been accepted. The credit card provider might provide an assumed credit limit before but this will have no bearing on how much credit you will actually be offered but can serve as a good guide.
Credit card providers have different internal scoring systems to work out what credit limit they will offer you. This will include :
- Your previous repayment history on credit accounts listed on your credit file
- Your income
- Your monthly expenses
- Your credit score
- The amount of available credit you currently have access to
- Your current debts
You can find your credit limit by:
- Calling your credit card provider
- Logging into your mobile app or web app
- Looking at your credit card statement
What happens if you go over your credit limit?⛔
Some credit card providers do let you spend over your credit card limit but they will charge you a fee for doing so.They may also restrict your spending until you clear the balance which went over your credit card limit.
Some credit providers will reduce the credit limit available to you and increase your APR(interest rate) even if you are on a promotional rate.You should be given 60 days to accept or reject any increase in APR and clear your outstanding balance. Going over your available credit limit can also be reported to the credit bureaus. This may damage your credit score as it will seem as you are not good at managing credit.
If you constantly go over your available credit limit then your credit card provider may close your account and require you to pay any outstanding balance in a short time frame.
How to increase your credit card limit??✔
IAs stated above, credit cards work by providing you with a credit card limit.
If you find yourself nearing your credit limit or constantly going over it, you may want to ask your credit card provider if your are eligible for a credit limit increase and increase your credit limit.
Your credit card provider may carry out another credit check which may damage your credit score if you are rejected. You should always ask for a credit limit pre-approval via a soft credit check which only you can see on your credit file.
You can increase your credit card limit by:
- Applying for an increase online
- Calling your credit card provider over the phone or
- By writing to your credit card provider
Your credit card provider can also change(increase or decrease) your credit limit without asking you.
They could do this if:
- Your spending behaviour is unusual
- You missed a minimum payment
- Your credit score has fallen significantly
- You go over your credit limit repeatedly
If you consented to having your credit card limit increased without notification then they can do this.
Tip: Credit limits on balance transfers indicate the maximum amount of money you can transfer to a balance transfer credit card. Not all balance transfer cards will allow you to use all your credit limit on a balance transfer.
Tip: The Golden rule is to spend no more than 30% of your available credit limit as this will boost your credit score.
How to manage your available credit??
This is all about how much credit you have available to spend on credit cards and overdrafts. Your credit to debt ratio is the difference between your combined debit balances on your cards and bank accounts and your combined credit limits/overdraft limit.
You need to find the fine line between not having too much credit as lenders may think you could rack up more debt by spending it all and not getting too close to your credit limits, which makes it appear as if you are in desperate need of cash.
The general rule of thumb is that if you have debts, lenders prefer that they make up less than 50% of your available credit. So if you have a combined credit limit of £20,000, they’d rather you use less than £10,000 of it.
If you are already following this rule it’s also wise to avoid lowering your credit limit so not to appear as if you are using all of your credit and hence seem desperate.You should also avoid having way too much credit than you will feel comfortable paying back if you used all of it.
Credit card minimum payment
What is a credit card minimum payment???
A credit card minimum payment is the minimum a credit card provider will require you to pay every month if you have an outstanding balance on your credit card. Credit cards work by allowing you to carry a balance which you dnt have to pay in full each month but rather a portion of that balance, this is your minimum payment.
The minimum payment is actually a fixed percentage or fixed minimum amount but as you use your credit card this number moves in line with how much of your balance you have actually spent.
E.g You credit card provider might want your credit card outstanding balance(The amount you owe on your credit card) at the end of the month to be no more than 10%. This means if you have used all your available credit for that month your minimum payment is 90%.
Assuming your credit limit is: £1000
And you spent: £900
Your minimum payment will be: £900
If you spent £500, your minimum payment will be: £400
Essentially your minimum payment is whatever you have to pay to bring your account up to the maximum outstanding balance allowed by your credit card provider before they will impose a charge(In the case above this is £100 or 10% of the available credit limit) the credit card provider will allow you to carry over from one month to the other without any charge.
If you do not pay your credit card in full but pay only the minimum payment then your credit card provider will charge you interest on your outstanding balance.
Credit card balance ??
If you don’t make the minimum payment on your credit card for a given month your credit card provider will charge you a fee and charge you interest on the outstanding balance. This will continue until you make the minimum payment.
Paying only the minimum payment on your credit card is the fastest way to accumulate debt. This is because you will begin to accrue interest rate and charges on the outstanding balance for every month you have an outstanding balance.
Any outstanding balance you have on your credit card will also be reported to the credit card provider and this will indicate if you made the minimum payment on your card. If you haven’t then this will be marked as negative and your credit score will go down.
Paying off your balance in full each month is the best way to go about things but if you find yourself struggling then considering a 0% Balance transfer card might just save you a considerable amount of money in interest rate charges and fees.
Credit card fees and charges??
Credit card fees and charges may be levied upon you if you do not stick to the terms of your credit agreement. These fees can be fixed amounts or interest rate charges.
The charges include:
Interest rate charges on purchases:
Credit cards will charge you interest on any purchases you make if you do not clear your full balance on or before your payment is due each month.
Cash advance charges:
Cash advance is described as using your credit card for anything that will usually require cash upfront. This includes withdrawing money from the ATM, gambling etc Your credit card provider will charge you interest for the cash advance which is usually higher than the percentage charged on purchases and may even charge you further interest known as cash handling fee.
Foreign transaction charges:
If you use your credit card in any other currency other than the one specified in your credit agreement your credit card provider will charge you a foreign transaction fee.
Late payment charges:
Your credit card provider will charge you a fee for failing to make your minimum payment on or before its due date.
Balance transfer fees:
You current card provider may charge you a fee for moving your balance to another credit card.
Annual credit card fee:
Some credit card providers charge annual fees. You can pay this in full or it will be added to your monthly outstanding balance.
Interest free period
You have a set period of time during which no interest is charged, usually between 20 and 55 days. This is called the interest free period. After that, if you do not pay the full balance on time interest may be added to the account.
Some cards offer a special deal where you are not charged interest even if you do not pay the balance off in full. The credit agreement tells you what rate of interest is being charged and when it will be added to your account.
Credit cards have a Statement due date. This is the date on your statement (credit card bill) by which you must pay at least the minimum payment to keep your account in good standing.
The credit card provider will send you a statement each month. The statement shows:
details of each amount spent on your card since your last statement
details of interest and other charges added to the account
the amount due (the balance)
the date you must make your payment
the amount of the minimum payment
how and where you can make payments
how to contact your credit card provider
It’s important to check your statement carefully to make sure it is correct and tell your provider straight away if you think there is anything wrong with it.
ps. Billing cycle: A set period during which you make purchases. After the period is over, you’ll receive a bill, and will have about a month to pay it.
Section 75 Credit card protection??
Credit cards issued in the UK offer a great deal of credit card protection by law. If your card is lost or stolen you can ask your bank to cancel this instantly and they will also refund any more spent on it during this time.
Credit cards also provide protection for transactions between £100 and £30,000. This protection comes from section 75 of the consumer credit act. The minimum protection of £100 applies per item. You may also get protection for charges under £100 via a chargeback scheme.
You will not need to pay the full price with your credit card to get protection under section 75 of the consumer credit act but rather just a deposit will provide your protection for the full amount.
You can also claim for more than the cash price of the item or service and your credit card provider will have to bear this claim. The claims could be about consequential loss or additional expenses.
Any claims on a credit card will need to be made by the main card holder and not the secondary card holder. The only exception are if it was bought for the main card holder or it was a joint purchase. Different credit card providers treat this differently so it is worth asking them prior.
The main problems that are covered under credit card protection in the UK:
- The company did not supply the goods or service or the goods or service were not up to standard
- The company has misrepresented what it is selling or it is not fit for purpose. E.g buying a charger for a particular phone but the charger doesn’t work with said phone.
If you pay for your holiday with your credit card you will have the same protection as above except in cases where you buy a flight only where the third party was only contracted to provide the tickets and not the flight. E.g a travel agent
You might not be able to claim for any costs that were not necessary. E.g if you extend your holiday after an airline goes bust.
To make a claim under section 75 of the consumer credit act you should first attempt to contact the supplier to see if they will give you a refund and pay you any money you are making a claim for.
If they do not respond or are not willing to do this you should then contact your credit card provider informing them that you have attempted to contact the supplier and this has been unsuccessful then inform them that you are making a claim under section 75 of the consumer credit act. You should provide them with as much evidence as possible including receipts, emails etc.
Types of credit card
There are various types of credit cards:
purchase credit cards:
allow you to make purchases and charge you interest on any balance.
Cashback and rewards cards:
cachback and reward cards offer you cashback and rewars points whenyou make purchases
Balance transfer cards:
llow you to transfer the balance frim another credit card.
What should I look for when getting a credit card??
When getting a credit card you should first consider your reason for wanting a credit card. This could be:
- To build credit
- To manage your finances better
- To borrow money
- To earn rewards such as cashbacks, air miles etc
- To save money by transferring a balance or paying off a loan
Your purpose for getting a card will then lead you to know how you will be using the card. Will you be paying off the full balance each month or will you be carrying on a balance for an extended period in time?
Your answer to this question will show you what need to be prioritised when considering a credit card. If you intend to carry the balance for an extended period in time then interest rate should be prioritised and you should look for cards that might offer a 0% interest on purchases offer for an extended time.
If you want to save money by transferring a balance or paying off a loan then you should consider balance transfer cards that preferably have a 0% introductory period as well.
If you want to use the credit card overseas then you should consider credit cards made specifically for this purpose and don’t charge fees on foreign transactions.
You should always consider the following things when looking for a credit card.
The credit limit:
This might be the most important factor to you as it lets you know how much you can spend. Credit limits can increase after a few months of good credit behaviour.
This lets you know how much interest you will get charged on any outstanding balance if you do not pay your balance in full on or before its due date.#
This is the amount the credit provider will ask you to pay back each month. If you do not pay this each month you will be charged late payment fees. You will also be charged interest on the total outstanding balance.
Some credit card providers charge annual fees, this can be paid in full or added to your outstanding balance.
There might be charges for going over your credit card limit, using your credit card for cash advances or using your credit card to pay in foreign transactions.
Introductory interest rates:
You should always check if the credit card provider is offering introductory interest rates and for how long. Introductory rates are usually cheaper ratea which then increase after a fixed time.
Loyalty points or rewards:
Some credit cards offer rewards in the form of points which can be exchanged for miles, hotel points, cash back or even to purchase goods.
Some credit card provider offer cashback on spending but they usually only do this if you pay your monthly balance in full each month.
Before applying for a credit card you should ensure you know your credit score and affordability. This will give you an idea of what products you will qualify for. If you are plugged into a financial wellbeing platform then you will automatically see what credit cards you are eligible for. Checking your credit score will also give you the chance to do some repairs before you apply.
If you have little or no credit score then your best chance of a credit card is with your bank or possibly with credit builder credit cards. Regardless of which route you take to get a credit card, good financial behaviour will ensure your financial wellbeing is always in check. Paying your debts off early, always looking to switch and never overspending are a few things you should always look to do.
Getting a credit card for the first time is simple. You simply need to know how a credit card works, the credit cards you are eligible for and then apply. You can see what credit cards you are eligible for with a credit card eligibility platform and compare to see what fits you best.
When you get your first credit card you should ensure you:
- Pay your balance in full each month, this will ensure you don’t have any interest charges
- Avoid withdrawing money from the ATM or gambling with your card.This will ensure you avoid all Cash advance charges.
- Check your credit score regularly. This will let you know if your good behaviour is paying off and allow you to move on to better credit cards.
- Monitor your account regularly to ensure you don’t go over your credit limit. You should ideally be spending less than 30% of the available credit limit to boost your credit score.
If you need financial advice and you live in the UK then you could contact the Money Advice service over the phone or via chat for impartial advice.
You can also contact the debt charity “Step Change” if you are in debt and need help.