Credit Cards

This article will cover the different types of credit cards, the main things to look out for, and the reasons why you might consider applying for a credit card. For more information on this & other financial topics, we highly recommend checking out our Finance Homepage.

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What is a credit card?

When you are approved for a credit card by a bank or building society, you enter an agreement with them that you are allowed to spend up to an agreed limit using your card for an agreed amount of interest on the balance if you do not pay them back within one month. The bank will pay for what you have bought in full and will send you a bill telling you how much needs to be paid off in full to avoid being charged interest, or the minimum amount needed for that month to avoid being penalised. A pitfall of credit cards is that there is no guarantee whether you will be accepted for one until you apply and each application can negatively impact your credit score if you are rejected. Too many applications can also negatively impact your credit score. There are eligibility checkers available (see resources below) that can give you the likelihood of acceptance and these are worth checking before applying to make sure you are applying for a credit card that you are most likely to be accepted for.

APR: Annual Percentage Rate

This is the interest rate a credit card holder would pay on the balance in their account if it is not cleared each month. Typical rates range from 19%-22% and can be as high as 60% for those with a lower credit score.

There may be different interest rates for how you use your card, for example, 19.9% for purchases and 23.9% for cash withdrawals. In this case, your  repayment will go towards clearing the most expensive debt on your statement first, which is known as ‘allocation of payments’

Why have a credit card?

A credit card is a useful tool for multiple situations. It is helpful to pay for small expenses on your credit card and pay off the amount in full each month to help you build a good credit history. You can use your credit card to make a big purchase if you do not have the cash at hand and spread the cost, this can incur an interest charge depending on the credit card. You can also have a credit card ready as a safety net for unforeseen expenses, such as if your car suddenly needs repairs. If you stay on top of your credit card use and pay off any bill incurring interest in full by the end of the month, a credit card can be a helpful tool in your personal finance repertoire.

Types of Credit Cards

Basic Credit Card

This credit card is the basic product available via most banks. It has an interest rate (which can be quite high) from the outset and likely a low credit limit. This kind of credit card is most likely to be used by those who have a poor or no credit history, students and those on lower incomes. This kind of credit card, if used regularly, should be paid off in full every month to prevent debt building up and incurring interest charges.

Balance Transfer Credit Card

This type of credit card allows an existing credit card balance to be transferred from one credit card to another. There are good offers available, such as low or no transfer fees and/or 0% interest up to a particular period. These cards can be useful for giving you more time to pay off your credit card balance without having to pay interest once your previous credit card introductory offer has come to an end. A balance transfer fee is usually a certain percentage of the balance being transferred.

Purchases Credit Cards

Many credit cards offer a 0% interest for a certain number of months on purchases for those wishing to make large purchases and spread the repayments. It forms a great way to cheaply borrow money in the short-term and can be a useful way to cover a large planned expense, such as a holiday or a car deposit. The interest rate, once the low or no interest period ends, reverts to a relatively high interest rate and so it’s important to keep the date in mind. It can also be very easy to build up debt on such credit cards as if you are paying the minimum balance each month, you are not being charged interest and so it can be tempting to add more purchases onto the card.

Reward Credit Cards

For individuals who regularly use their credit cards and pay off the balance in full, a rewards card is a good idea. These give you points or cashback on your spending and can be a good way to use your regular spending as a way of being rewarded. Sainsbury’s, Tesco and M&S give you points on your purchases, Amex gives you cashback and/or frequent flyer miles that can be exchanged for flights. Some reward cards do charge a fee so it is important to check whether your level of spend will justify this fee. There are also stipulations such as minimum spend in a certain period of time in order to earn certain rewards, so check these carefully. Otherwise, reward cards can be a nice way to make some extra points/cashback on the money you’d spend anyway.

Store Cards

these used to be quite popular when department stores were the go-to for most high-street shopping needs. A store card gives you an agreed amount of credit at a certain interest rate for a particular store and cannot be used elsewhere. These would have been useful to spread the cost of large purchases, such as furniture, as the interest rates may have been more favourable or the criteria for being accepted were lower than banks. Store cards are not as favourable as regular credit cards as they limit where you can spend them and the interest rates can be higher than most banks.

All-Rounder Cards

These cards offer deals on a combination of balance transfer and purchases. For example, you can get a card with 0% interest for 15mths on balance transfers and 0% interest on new purchases for 18mths. The pitfall of this kind of card is that you are transferring existing debt whilst having the opportunity to accumulate more debt due to the excellent offer on purchases. I’d recommend this type of card for those who are on top of their spending and well organised to ensure that they do not incur interest charges or build up unmanageable levels of debt.

Key Tips

Apply for a credit card for the right reasons- if you are using a credit card as an alternative money source then this can be dangerous and a good way to build up unmanagable levels of debt.

If you apply for a credit card and you are rejected, leave it a few months before applying again. Try and figure our why your application may have been rejected, however, trying to apply for credit cards that you are inlikely to be successful with can significantly impact your credit score for the worse.

Don’t have too high a credit limit if you don’t need it. You can benefit from having the minimum amount of credit you need to free up available affordability for other applications such as for a car lease or mortgage.

Set up a direct debit to pay off your credit card bill in full each month to make sure you never miss a payment or incur an interest charge.

Keep dates in your diary or calendar and set a reminder for when low or 0% interest rate periods end so you know that you need to pay off the full balance or transfer it before incurring an interest charge.

Resources & References

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