Credit cards are one of the most successful financial products of all time, and it’s easy to understand why: they’re a convenient tool for making secure payments, they offer you enhanced consumer protection and – when used wisely – they can provide a source of cheap borrowing.
However, to get the most from your credit card – and avoid costly mistakes – it’s worth taking a few minutes to learn how credit cards work.
Credit cards enable you to access prearranged loan or credit line from the credit card issuer. So, every time you use your credit card, you’re taking out a loan. Unlike most loans, though. credit cards let you avoid paying interest entirely if you manage to clear your balance in full by its due date. If you can’t afford to clear your balance in full, credit cards let you roll-over your balance from month to month, so long as you make the minimum monthly repayment.
In short, credit cards offer greater flexibility for managing your finances than traditional loans, which require fixed monthly payments regardless of your financial position in a given month.
Credit cards also offer enhanced purchase protection, which ensures that your card issuer will repay you for faulty goods (costing between £100-£30,000) that you purchased with a credit card. A similar scheme (chargeback) also protects debit card users, but the purchase protection offered by credit cards (enshrined in law by Section 75 of the Consumer Credit Act) is a lot stronger.
The flip side, though, is that the interest rate on credit cards is much higher than loans. This means that loans are generally better for long-term debt, where you won’t clear your balance within a few months. With that said, 0% purchase and balance transfer cards with very long interest-free periods (30+ months) can be cheaper than loans – as long as you pay off your balance in time. In a similar vein, using a money transfer credit card to pay off an existing loan or overdraft can be a savvy move.
Although credit cards can be a great vehicle for minimising debt, there are a number of not-so-obvious fees, charges and potential pitfalls that you should know about before you jump in.
Credit card issuers are businesses, and they need to make money. However, aside from annual fees (which are unavoidable where charged), most charges associated with credit cards can be avoided with good account management. This means you can get all the convenience and enhanced consumer protection without ever paying a penny. You’ll also build up a good credit history, which will help you get advantageous rates on other credit products in the future.
Now read our guide to using a credit card correctly
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Last updated: 2 March, 2020