Credit cards are peculiar little things. Some consider them to be a life saver, while others think of them as an unnecessary evil. No matter what side you are on, the truth is that most of us use them. If you plan to get on team credit card, you should get familiar with how credit cards work.
The safest way to prevent going down the debt hole is to know the intricacies of credit cards. I know that you must have many unanswered questions.
Instead of listening to a formal and scripted speech of a bank clerk, let me explain this plainly. I’m about to tell you all about the need-to-knows of credit cards in simple and plain English. Let’s dive in!
Why use Credit Cards?
So the first thing you’re going to want to find out is, what’s the actual point of getting a credit card? It sounds like a load of faff but believe me, it’s saved me more times than I care to mention.
Picture this… you’ve got £2.01 left in your bank account, payday is 3 weeks away and you’ve got to pay your £500 car insurance renewal in the next week. What do you do? Well, you just pay it on your credit card!
Credit cards allow you access to immediate funds that you don’t necessarily have at the point of your desired purchase, BUT you will have the funds in a short period of time (like on payday).
It’s SO important to note – only spend money that you can afford to pay off in the foreseeable future. My advice would be to never spend more than 50% of your net salary.
50% of your net salary should give you enough cash to cover any direct debits, rent, etc. that will be paid from your current account and leave you sufficient funds to clear the credit card balance.
Credit Cards vs Loans – the Difference
Credit cards are described as loans, but they’re definitely not. So what’s the difference then? The difference is that a loan is typically a one-time thing while credit cards give you access to funds as and when you need them for as long as the credit card is valid.
The similarity is that in both cases the bank assesses your suitability. The bank needs some assurance that you are financially capable of paying them back. Therefore, it is unlikely that you’ll get a credit card or a loan if you are unemployed with damaged or non-existent credit history.
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How Credit Cards Work
Now, here comes the main lead – the question you’ve been anticipating – how do credit cards work?
The process is actually quite simple. The bank provides you with a pre-set credit limit. The limit can be a few hundred pounds or even several thousand pounds.
Before you start dreaming about what you’ll do with thousands of pounds of credit, you should know that the limit depends on your credit score and income.
The credit card can be used for:
- Card purchases
- Cash withdrawals
- Balance transfers
Card purchases are most common for credit card owners. You swipe the card and the amount you spend gets credited to your balance (the amount you owe).
If you pay off the bill from your credit card each month, you won’t need to pay the interest on the borrowed money. And that’s the goal – not to pay the interest.
Paying the interest isn’t the only downside. The late payments will be visible on your credit history and can affect your credit rating.
You do get a set minimum payment. That is, a minimum amount you have to pay back each month to avoid unwanted charges and keep your account in good standing.
However, as suitable as this sounds, there is a trick. If you just keep paying the minimum payment, it typically only covers the interest and a small part of the debt. Thus, with time, your debt will accumulate, making it hard for you to pay it off.
Therefore, if you are playing with the thought of getting a credit card, be prepared to be committed to paying off the spent amount regularly. Considering that 60% of people that use credit cards pay off the total balance each month, you can do it too!
When you first get the card, you can be given a 0% introductory period. This is a set period of time for which you don’t have to pay the interest, even if you don’t pay off the amount you spend at the end of the month.
Do pay attention to what the 0% introductory period covers. It can cover card purchases or balance transfers or both. However, it won’t include cash withdrawals.
But, I can’t stress enough the importance of paying off your balance regularly. After the period is over, you’ll have to start paying interest on any aging credit card expenses. So, don’t let the 0% introductory period tempt you to falling into debt.
How Do Cash Withdrawals with Credit Cards Work?
Credit cards allow you to make cash withdrawals. The amount you withdraw will be assigned to your credit card balance.
However, it is highly recommendable that you avoid this functionality. The thing is that interest for cash withdrawals is charged on a daily basis from the day when you made the withdrawal.
But that’s not all. The interest rate is typically higher for cash withdrawals than for payments made with the card.
If you do get your hands on a credit card, try to use it solely for card payments. Credit cards are pretty much accepted in every store so avoiding cash withdrawals shouldn’t be an issue.
How Do Balance Transfers Work?
Balance transfers allow you to move your debt from one credit card to another. So, if you already have a credit card with the debt and you get a new one, you can move the debt from the old card to the new card.
The reason why people do this is to avoid paying the interest at the end of the month. When they get a 0% introductory period on a new card, they get more time to pay off the debt before the interest kicks in.
There is, however, a fee for transfers which is typically around 2%-5%. Some banks waive the fee to entice credit card owners.
How to Apply for a Credit Card
The application is pretty simple. You go to your bank, state that you want to apply for a credit card, and depending on the bank, they’ll let you know what documents you need to supply.
Bear in mind that you must be over 18 to apply for a credit card. Some banks require that you are over 21.
Be aware that a bank will check your credit. So if you have damaged credit or no credit history, you might consider applying for a secured credit card.
A secured credit card demands that you put down a cash deposit. This deposit equals your credit limit.
With a secured credit card in motion, you’ll boost your credit.
Key Credit Card Terms
If you want to enter the credit card world, you should be able to understand the lingo. So, here is a concise glossary of key credit card terms:
- Credit card limit – The amount of money you can spend;
- Available credit – The remaining amount on your credit card you have left to borrow;
- Balance – The amount of money you have to pay back to the bank;
- APR (Annual Percentage Rate) – The interest rate you pay for the amount you don’t pay off within the set period;
- Minimum payment – The minimum amount you need to pay off to avoid fees; and
- 0% introductory period – the period for which you don’t have to pay the interest
To Use Credit Cards, Or Not to Use – That Is the Question!
Yes, that is the question – a question only you hold the answer to. But, I’m not here to tell you what you should or shouldn’t do. My role in this affair is solely to provide information on how credit cards work.
Hopefully, now you have a better idea of what credit cards have to offer and how it all works. With the key terms in your possession, you can head to the bank ready to question them thoroughly on the conditions of getting a credit card.