Credit where credit’s due: A beginner’s guide to credit cards

credit cards
A selection of credit cards, yesterday
"Someone with an impeccable financial history, who’s never borrowed so much as a crumb, is viewed as more of a credit hazard than someone with several store cards."
  • | by Rachel England

We live in a very backwards economy. Want a mortgage or a loan? Chances are you’ll find those tricky to get hold of unless you are, or have been, in debt.

That’s because unless potential creditors can see on your credit record that you’re able to deal with debt, they’re unlikely to let you take on more. This means that someone with an impeccable financial history, who’s never borrowed so much as a crumb, is viewed as more of a credit hazard than someone with several store cards. Mad, right?

So to bolster your credit record, it’s worth considering taking out a credit card  (and using it wisely!) to prove you’re a savvy spender. But for the uninitiated, the whole business can be a bit taxing.

How do credit cards work?

In short, a credit card gives you instant access to a pre-arranged amount of money which you can spend as you like, but must pay back. They work just like a debit card, with a chip and pin. After making your first purchase, you’ll have a ‘grace period’ (usually up to 56 days) to pay off the card in full without any penalty, after which you’ll start paying extra fees and charges.

These fees and charges will depend on the card you have. Every card comes with an APR, which stands for Annual Percentage Rate. This is the percentage of interest you will pay on purchases if you don’t pay off the full balance within the grace period, and is charged monthly. So for example, you spend £500 on a credit card with a 16% APR. This would result in £6.67 interest being added a month over the course of the year.

These charges can rack up if you’re not careful, though. All cards ask you to make a minimum monthly payment – usually around 2.5% of the balance – which is then tacked on to the interest for the month. In this example, then, you’d be required to pay £19.17 in charges without even making a dent in the actual balance. So avoid the minimum payment trap by paying off as much of your balance as you can every month.

Know your limits

When you apply for the card you’ll be given a credit limit which will reflect your credit record, so it may be quite low to start with. Respect your limit! Maxing out your card can result in hefty fines, as will late payments.

Your bank will send you a statement every month to remind you of the payment required and current balance, but many people find it easier to set up an online account for the card to keep tabs on it regularly. Payments can be made via online transfer from your current account, over the phone, by cheque or via Direct Debit, which can be set up once you receive your first statement, and is quite helpful for forgetful types.

What’s right for you?

So, those are the basics. The next question: which type of credit card is right for you? Households receive hundreds of unsolicited leaflets promoting different cards every year, because – make no mistake – banks want your business. After all, those fines and that interest goes straight into their pockets. Therefore, they’ll tout dozens of offers with attractive bells and whistles in an attempt to get you to pick theirs. They fall into three broad categories.

Interest free purchase offers

These cards will offer a much longer grace period than usual; up to as much as 16 months instead of the standard 56 days. Not surprisingly, these tend to be pretty popular around Christmas and the summer holidays, when the big spending happens. They can be useful if you’re planning on making a hefty purchase as you can then spread the cost over a number of months, interest-free. But remember, the balance needs to be cleared by the end of the interest-free period, otherwise you’ll start accruing charges.

Balance transfer offers

These may only really useful for people who already have a credit card. In this instance, you can shift the balance of one card on to another (usually for a small fee – around 3% of the balance), and then enjoy benefits such as an extended interest-free period, or a rewards programme (see below). Some credit card holders will continually ‘bump’ their balance from one card to another to avoid paying interest, and indeed, this can be a smart way to manage the debt in the short term. However, companies are clocking on to repeat offenders, which can limit your chances of getting a new card. It’s much better to pay off the debt as soon as you can, rather than shift it around.

Some great reward

Unless you’re planning on paying off your balance in full every month, then consider choosing a car based on its low APR, rather than any snazzy extras the bank may offer. However, there are several reward schemes that are worthy of note, and could prove fruitful alongside a well-managed credit account.

• Cashback credit cards offer a percentage cashback of your annual spend, which can provide a decent bonus if you’re a regular spender. Beware though, sometimes this is only applicable to certain retailers, or is capped at a particular limit.

• Air mile cards will offer air miles – redeemable for free flights – in line with a certain amount spent or frequency of spending (although airline taxes and charges will probably still apply).

• Shopping/points reward cards offer a number of incentives for shopping with a particular store, such as discounts or points which can be redeemed for goods and services.

It’s also worth noting that spending with a credit card offers a number of other benefits, such as identity theft protection and purchase protection. If you’re a victim of fraud, or find yourself in a tricky situation with a retailer following a purchase, you could file a claim with your credit card company and get a refund.

Some folk may find it difficult getting hold of their first credit card, whether because of other debts, a shaky job history or multiple previous addresses. In this case, repeated applications for credit cards can actually have a damaging effect on your credit rating, and you’d be better opting for a credit card geared specifically for first-timers (which can have whopping APRs), or a ‘secured’ credit card, which involves putting down a payment on the card before you can use it. Both scenarios aren’t ideal, of course, but once you’ve proven to the company that you can be trusted you may well have your pick of the deals available.