Credit cards explained
Often dubbed our 'plastic friends' because of their 'buy now, pay later'
concept, credit cards can be a flexible and convenient way to borrow money - providing
they are used responsibly and managed effectively. To help you decide if a credit card
is right for you, we've put together a short guide that explains how they work in
more detail.
What is a credit card?
A credit card is a payment system so called because of the small plastic card that's
issued to users. Each credit card is the subject of a credit agreement between the
cardholder and the credit card provider; this agreement is regulated by the Consumer Credit
Act 1974 and details key financial information plus other information, such as that relating
to missed payments, theft, loss and misuse of the card, your right to cancel and general
credit card terms.
You'll receive a copy of the credit agreement when you make a credit card application.
How do credit cards work?
Every time you use your credit card, whether it's to make a purchase, to withdraw
cash or to transfer a balance from another credit card, you are effectively borrowing
money - therefore each month you'll receive a statement, either in the post or
online, that details the transactions you've made during the statement period plus:
- Your credit limit and available credit
- Any payments or credits you've made to the account
- The minimum payment amount and the payment due date
- Any interest charged along with next month's estimated interest
If you do not pay off the full amount outstanding then any payments you do make will be allocated
to the outstanding balance in a specific order, known as a 'payment hierarchy' (you can
find details of this on your credit agreement and it may also be included on your statement).
It's common for credit card providers to allocate payments so that transactions at the lowest
rate of interest are cleared first, with those at the highest rate of interest cleared last.
This type of payment hierarchy can make a significant difference to the amount of interest
you'll pay until you've cleared the balance in full, essentially meaning that
you'll pay more.
If you do repay your balance in full each month, then no interest is charged. However, if you
only make the minimum payment each month then it will take you longer and cost you more to
clear your balance.
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