Credit cards offer some handy perks like cashback and enhanced consumer protections on purchases – and of course the ability to pay off large purchases over time. However, they need to be used responsibly or they can cause more problems than they solve.
How credit cards work
When you use a debit card to make a purchase, money is taken directly from your bank account to pay for the transaction. With a credit card, the card issuer pays for the transaction, then sends you a statement each month.
The statement will list the transactions you made in the past month, along with and any balance owed from previous months. It will provide the total owed up until the statement date, and a minimum payment amount. This minimum payment will cover any interest and fees accumulated that month, plus at least a small portion of the balance owed.
Statements used to be sent in the post, but nowadays they will usually be sent electronically via your banking app.
- If you pay the full statement balance each month, you will not owe any interest on your purchases, regardless of the rate on the card.
- If you repay less than the full statement balance, you will accrue interest.
- If you fail to make the minimum payment, this is considered a missed payment.
Missed payments will damage your credit rating, your card issuer may charge you fees, and in extreme situations may take legal measures to recover the debt you owe.
How to pay your credit card
Payments to credit cards can be made manually at any time, using the bank details provided. However we strongly recommend using a Direct Debit to pay automatically.
When you set your card up, you will be asked to provide your bank account information so that payments can be taken each month using the Direct Debit system. You can set this to take either the full statement balance, or only the minimum payment.
For a card intended for normal day-to-day spending, we would always recommend setting up a Direct Debit payment for the full amount. This ensures you will not build up a balance.
If you’re worried about not having enough in your account on the day without some manual rearranging, or are intending to pay back a large balance over a period of time, set it so the at least the minimum payment is taken automatically. This means that even if you’re away, busy, ill, etc and accidentally forget to make a manual payment, at least the minimum payment has not been missed.
The automatic payment will generally go out a couple of days before the due date. Each statement will specify exactly how much will be taken and on what day.
How statement periods work
Statements are sent monthly, covering the month period immediately prior. The due date is typically 25 days after the statement date, however this number can vary from card to card.
For example, you could receive a statement dated 9th of November, covering transactions from the 10th of October to the 9th of November, with payment due by the 5th of December.
Your balance will not necessarily reach £0 when your statement balance is paid, as you may have used the card since the statement was generated. This is normal, these transactions will be covered in the next statement period.
Similarly, if you are carrying a balance, the statement will list the interest accrued during the statement period. If you pay the statement balance on the due date, you will still owe a little more interest for the period between the statement date and your payment date. This will be listed on the next statement.
Statement periods are typically based on the day your card was set up. It may be possible to change them if you would prefer the payment to come out on a particular date, but not all cards will offer this.
Fees and charges
It used to be common for credit cards to charge an annual fee regardless of usage. Most modern credit cards do not charge an annual fee, although there are some exceptions, particularly with rewards cards and cashback cards. Always check the “Summary Box” (key information about the card) before applying.
Most cards will charge you in these circumstances:
- If you do not pay at least the minimum balance on a credit card by the due date, or exceed your credit limit, you will be charged a fee (typically £12).
- Using your credit card to withdraw cash is called a ‘cash advance’ and you will be charged a fee (typically around 2-3% of the transaction) and start accruing interest immediately (often at a higher rate than the usual interest rate of the card). Never use your credit card to withdraw cash.
- Some transactions are considered ‘cash equivalent’ and are treated the same way as cash advances. Examples can include transferring money from the credit card to a bank account, online trading such as buying stocks and shares, and gambling transactions.
- Using your card to make purchases in other currencies will typically cost a 2-3% fee.
Not all cards charge every fee – e.g. ‘travel cards’ don’t charge to use foreign currencies, and ‘money transfer’ cards are specifically used to transfer money from your credit card to your bank account. Choose cards that suit your needs, and always read the Summary Box carefully for details of fees and charges.
Why credit cards can be trouble
Interest makes everything more expensive
Credit cards have interest rates ranging from 0%-40%. A typical “all-rounder” card will be in the range 15%-20%, but some “bad credit” cards may have very high interest rates.
These high interest rates make purchases more expensive than they appear. If you only pay off the minimum payment every month, even a modest purchase can take a decade or more to pay off, costing many times the original cost of the item in interest.
The higher the interest rate, and lower your monthly payments, the more dramatic this will be. Use this calculator to check the true total cost of a credit card balance.
Credit cards can confuse your mental budget
It’s easy to accidentally ‘double spend’ using a credit card. This means treating the same £100 in your budget as though it can be spent twice – once on your debit card and once again on your credit card.
We strongly recommend you think of your credit card as no different to your debit card, and only spend within your means. This is based on the income and savings you currently have, not future income.
If you’re determined to buy something on credit rather than waiting until you have enough saved to pay upfront, take the time to make a plan.
For example, perhaps you want to buy a £1000 laptop but don’t have any savings. You get a 0% card, so you’re not worried about interest. You decide you will pay £100 per month for 10 months.
Where will this £100/month come from? If you weren’t saving £100/month before, what makes you think you can afford a new £100/month bill? What habit or expense will you change?
If at all possible it would be safer to make that change, start saving £100/month, and buy the laptop when you have the full amount available.
Debts can quickly mount up
As credit cards allow you to spend more money than you actually have, sometimes much more, it can be easy to spend beyond your means.
We regularly see posts from people whose monthly budget is squeezed dry by credit card payments. It’s entirely possible to end up in a situation where even the minimum payments are unaffordable alongside essential bills and expenses. You then end up making card payments one day but putting your food or commute on a card the next, and not making headway.
High interest rates (>10%) especially can have you making payments on the same debt for years without reducing the balance significantly. Or sometimes payments that seemed affordable at one time become a struggle to keep up with as other costs rise.
While card companies have some legal obligations not to lend irresponsibly, it’s also your own responsibility to manage your finances and ensure you don’t borrow more than you can afford to repay.
If you’re struggling with credit card debt, see our debt page.
Advantages of credit cards
The warnings above shouldn’t put you off – used responsibly, credit cards can be useful tools.
Section 75 Protection
Section 75 of the Consumer Credit Act 1974 sets out that the credit card company is jointly and severally liable for a breach of contract or misrepresentation by the retailer. Therefore, if you have problems settling a dispute with a trader, you can contact your credit card provider to make a claim and recover any losses. This is particularly useful if the retailer has gone bust.
To qualify for protection under this act, all you need to do is make a purchase for goods or services that cost over £100 and no more than £30,000 (note this is the price of the item – 2x £60 items would not qualify) and pay at least part of that by a credit card from a separate provider than is the supplier of goods. The credit card needs to be in your name.
You don’t have to pay the full cost of the goods or service on your credit card if you don’t want to or don’t have a high enough limit. Even if you pay £1 on your credit card that’s enough to qualify.
Note, there are disputes over how Section 75 applies when the payment goes through an aggregator such as PayPal or Curve. It has not yet been tested in court so it’s best if the retailer accepts it, to pay directly by credit card rather than an aggregator. Though if you do encounter a problem, aggregators offer their own Buyer Protection schemes which may cover a problem with your purchase.
Your credit card is relatively ring-fenced from the rest of your finances. If your credit card details are compromised and used to make fraudulent transactions, your credit card issuer can simply wipe the transactions from your account, and you are not out any money.
In contrast if your your main bank account’s debit card is compromised and money is taken from it, you may have trouble paying your bills and daily expenses while it gets sorted out.
Free (or cheap) short term credit
After a purchase, repayment may not be due for as long as 56 days afterwards. This can be helpful if you have irregular income, you need time to move money out of savings, or have an unexpected emergency.
If paid off quickly enough (such as within 1-3 months), a credit card is likely to be cheaper than most overdrafts or payday loans. However consider carefully before carrying a balance.
Having and using a credit card can improve your credit rating by demonstrating your credit worthiness.
If you’re getting a card for this purpose:
- Use it for your normal expenses only – e.g. food shops or petrol. Don’t let having a card affect your spending
- Pay it off in full each month, using a direct debit. Never pay interest
- Don’t exceed your credit limit
- Never take cash advances
Some websites suggest keeping your credit usage to within a certain % of your credit limit – however they all disagree on what percentage to use! We suggest you don’t worry too much about this, and just focus on using the card regularly, staying within the limit, and paying it off on time each month.
Note you should also not pay the balance off early. Wait at least until the statement is generated, as this is when your usage is reported to the credit rating agencies. We truly recommend using direct debit and not worrying about it.
Paying for hotels and car hire (especially abroad)
Some transaction types, like booking a hotel or hiring a car, can require large “holds” or “pre-authorisations”. This is where a retailer reserves a portion of your account balance for future expenses they may need to charge, to ensure the money is available to them.
Funds “held” for this purpose cannot be spent until the pre-authorisation resolves. With a debit card this can be problematic as it may interfere with your regular bills and savings transactions. A hold on a credit card is usually less disruptive, as you are unlikely to want to borrow up to the limit.
Additionally, in some countries a debit card will not be accepted for these transactions and a credit card is required.
Some examples of “pre-authorised” transactions are:
- “Pay at Pump” petrol stations will typically pre-authorise a sum of up to £100 when the pump is released. When fuelling is completed, the actual amount will be debited from your account but it might take several days for the pre-authorisation to “drop off” and be available for you to spend again.
- Car hire companies will typically take a substantial pre-authorisation (£500-£1500 is not uncommon). Some car hire companies may restrict which cars you can hire using a debit card, or not take debit cards at all, especially abroad.
- Hotels may pre-authorise the full cost of the hotel stay and an additional amount of money to account for incidentals (room service, bar bills and the like). They may take the pre-authorisation at check-in, or a day or two in advance. In some countries, hotels may not accept a debit card.
Stoozing is the name for holding debt on a 0% credit card while holding an equivalent balance in a savings account earning a higher interest rate.
Since you can’t move money from a credit card directly into a savings account, you use your day to day spending. So for example, if you normally spend £500 a month on food, petrol and other purchases, instead of paying for them with your debit card you would use a 0% credit card. This frees up £500 per month of your income to transfer to a high-interest savings account. When the 0% promotional period on the card ends, you use your savings to pay off the bill, and keep the interest you earned over this time period.
By pairing these two financial products, you earn ‘free money’ off the difference in interest rates (around 0-5%). But this requires solid financial discipline to make sure you don’t spend more than you would have on debit, and that your savings keep up with your spending. If your card balance starts to overtake your savings, you’re not stoozing, you’re in debt.
More information from MSE: https://www.moneysavingexpert.com/credit-cards/stooze-cash-credit-cards/
Applying for a credit card
Always use an eligibility checker, such as:
Types of cards
Cashback / Rewards: Some credit card providers offer a small amount of your purchases back either as cash or points. This is typically works out up to 0.5% for most cards, and up to 1% for American Express.
Interest-Free Purchases: 0% interest on your transactions for the first 12-24 months. Can be used for a big purchase you will pay off within that time, or for stoozing. After the 0% promotional period, interest rates will rise sharply.
0% Balance Transfer: For paying off old cards that are at a high interest rate and replacing with a 0% card. This will normally cost a fee – you will need to calculate whether this is outweighed by the savings on interest. Note the 0% interest rate applies to your balance transfer only. Any purchases you make on the card will be charged interest.
0% Money Transfer: For transferring money from a credit card to your bank account, such as for making larger purchases that cannot be made on a credit card. Effectively gives you a time-limited 0% cash loan. Purchases on the card will usually be charged interest.
Travel cards: Cards with good exchange rates and no fees for transactions in foreign currencies.
Credit Builder cards: Cards which accept applicants with poor credit history. They will come with high interest rates and fees, and should only ever be used for normal day to day spending and paid off in full every month by direct debit.