How Do Credit Cards Work?
Avoid any financial mistakes by understanding how credit cards work.
The financial world can be scary and complicated. Between the complex jargon and the (sometimes terrifying) numbers, it can be a little difficult to navigate, especially as a student.
With the lack of financial education in schools, most of us leave without a clue how to take out a loan or even set up a credit card, and not forgetting how important it is to actually have a credit card. Isn’t it just free money? Sadly, no.
Jump to:
- What is credit?
- What is a credit card?
- How do credit cards work?
- What is APR?
- How do 0% interest credit cards work?
- How to get a credit card
- How to use a credit card to build credit
- Why can’t I get a credit card?
- Can I get a credit card with bad credit?
What is credit?
Credit, simply put, is money that you can borrow now and repay back at a later date. Sometimes the repayment involves interest, which means paying back what you owe but with a small fee added on top.
Credit is typically used to help cover large purchases or to help manage unexpected costs.
What is a credit card?
Credit cards are similar to debit cards, except the money on a credit card isn’t technically yours. It allows you to borrow money for purchases as long as you agree to pay it back at some point in the future, normally with added interest.
Banks and credit card providers will typically set a limit on the amount you borrow, for example £1000, but it can be much more than that depending on what you need it for and if you’re a suitable candidate for a higher limit.
They’ll also have fixed rules for you to follow when paying off the borrowed amount. This could involve a minimum amount you need to pay back each month.
How do credit cards work?
Credit cards are plastic cards which you can use in store, online or to withdraw cash. It allows you to spend money up to a pre-agreed, pre-set limit. Each month, you should get a bill showing you how much you’ve spent that month — which you will have to pay back.
If you can, it’s best to pay off what you’ve borrowed each month in its entirety, but you’ll need to pay off the minimum amount, at least. Your minimum payment will be set by the credit card provider, but it’s normally at least 1% of your outstanding balance. If you only pay the minimum amount back each month, you’ll likely have to pay interest, too. Unless you have a 0% interest rate which is available from some providers.
For more advice on credit cards, check out Citizens Advice.
What is APR?
APR stands for Annual Percentage Rate. This rate refers to the total cost of borrowing for a year, either on a credit card or a loan.
Included in the APR is the interest rate, plus any other charges you may have to pay, such as an annual fee. It aims to give you an estimate of how much it will cost you to borrow money over the year.
The higher the APR, the more expensive it’ll be for you to borrow.
How do 0% interest credit cards work?
0% interest credit cards are a great option as you won’t be charged anything extra, even if you only pay back the minimum each month. The 0% interest rate is set for a period of time, even up to a few years.
You’ll be able to spread costs by paying off less than the full amount each month, and still pay no interest. But, once the offer of 0% interest ends, you’ll have to pay the standard interest rates set by your credit or loan provider.
If you have a duration of 0% interest, you will still need to make the minimum monthly payments, and stay within your credit limit.
How to get a credit card
The first step before applying for a credit card is to figure out which one is right for your needs. You should do some research and compare different credit cards to see which has the best rates, including the APR.
Before credit lenders consider your application, they’ll check your credit score. This can help determine how reliable you are with repayments. If you have a bad credit score, you may struggle to find lenders to fulfil your application, or they’ll offer high interest rates — costing you more money if you’re unable to make repayments.
Some credit lenders may also have eligibility criteria you need to meet. These may include earning over a certain amount per year, or being over a certain age. Once you’ve filled out the application and made sure you’re eligible for the lenders criteria, they’ll review your offer and make a decision.
For more detailed information on how to get a credit card, head over to HSBC.
How to use a credit card to build credit
You’ll need a credit score for a lot of things later on in life. It can help determine your mortgage, credit cards and loans.
Even if you’re not in a position to buy a house or make large purchases, applying for a credit card and using it sensibly will help you in the long run. With a better credit score, you can get better rates which will help save you money.
If you have no credit history, you can start by using a credit card. The longer you have a credit card for, the better, so apply for one now to ensure you’re offered better opportunities and rates further down the road when you’ll need it.
You need to prove that you’re able to borrow and repay lenders promptly, so even though you might think that never having a need for a credit card should prove you’re able to manage money effectively, it might actually hinder you down the line. Lenders will need proof and they’ll use your credit score to determine how reliable you are.
To build your credit score, use a credit card for purchases you know you can repay each month. An example is to use a credit card to pay for your petrol or grocery shopping, which you know you may be able to pay for straight away (by using a debit card or cash), but a credit card means you can pay it off at the end of the month and build a good credit score. If you jump straight in and make large purchases, you’ll risk not being able to make the full repayments, which will have a negative impact on your score.
Why can’t I get a credit card?
There are many possible reasons that you’re unable to get a credit card.
If you already have existing debts or outstanding loans and balances on other credit cards, you may be refused another as you’d be at risk of going into more debt. Another possible reason for refusal is if you have an unstable work history or your income is too low. This will be because the credit card lenders believe you may be unreliable in keeping up with repayments.
Other reasons may include:
- You don’t have a credit history (or much of one)
- Your identity can’t be confirmed by the lenders
- Mistakes on your application forms
- Bankruptcies or county court judgements
Check out Compare the Market for more details and advice on why you may not be able to get a credit card.
Can I get a credit card with bad credit?
If you have a bad credit history, you may not be completely out of luck. While you might not be able to get 0% interest rates or a high credit limit, some lenders may accept you because they have different acceptance criteria.
You can apply for cards designed for people with bad credit. These are great for trying to improve your credit score. They often come with low credit limits and high interest rates, but keeping on top of the payments can help improve your score. If your credit score improves, you may be able to borrow more money or be offered lower interest rates.
Check out Student Beans banking discounts for the best student rates and perks.
