Credit Cards- How Do They Work & What Are Its Types

Credit Cards- How Do They Work & What Are Its Types

Credit Cards- How Do They Work & What Are Its Types

What are Credit Cards?

A credit card is a small plastic card that you can use to purchase goods or services on credit. It’s just like a debit card, but the money isn’t debited from your current account. Instead, it’s like a loan that you borrow from the card provider. A card provider can be a bank or building society. Credit cards are a lifeline when you have no ready cash. You can use these cards for shopping, earning cash back and rewards on your purchases, and reducing the cost of expensive debt by getting a low interest rate.

 

How Do Credit Cards Work?

If you want a credit card, you should apply with a card issuer like a bank or building society. Your credit score plays an important role here, just like in the case of loans. Before approving your application for a credit card, the issuer will generally look at your credit history. If you didn’t manage credit responsibly or never took credit in the past, you’re likely to have a low credit score. Due to any of these reasons, a lender may turn down your application. Or the lender might consider you and offer a less attractive deal.

If you have a good score, the issuer will give you a credit limit. This is the maximum amount you can spend with that card. For example, if your credit limit per month is £10,000, you can pay with your credit card till your payments total £10,000. The card company will also send you regular updates like your Credit Card Statement that has details of every transaction done using the card. It also contains the minimum amount you need to pay (2% to 5% of the amount you owe) and the due date for such payment.

 

Can I get Credit Cards with a Poor Credit History?

Generally speaking, any lender will carry out a credit check to see whether you’ll be able to pay back the credit. If you have a less-than-perfect credit score, it can make things difficult and you may not get the most competitive rates. Now, it so happens that not every successful applicant gets the advertised rates. The interest rate the card company advertises is the ‘Representative Annual Percentage Rate’ (APR). This rate is offered to just 51% of all successful applicants. So, if your application is in the remaining 49% and to top it off you have a bad credit score, you may not get a desirable rate.

However, banks and card providers don’t want to lose customers with a bad credit score. So they offer so-called credit builder cards to give them an opportunity to build a good credit rating. Be aware that these cards may come at a high rate of interest.

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What types of Credit Cards are available?

There are a lot many credit cards available to people. But every card may not be best for every individual. Choose the right type based on why you want the card, your spending habits and credit history.

  • Cash back and Rewards Cards:

With a cash back credit card, the more you spend using your credit card the more you earn. Sounds unbelievable? Yet it’s true. The standard rate typically lies between 0.25% and 2%, though some card issuers may also offer an introductory rate of upto 5%. The amount of cash back is often capped during this period.

Reward credit cards, in place of cash back, give points that you can redeem for your purchases or convert into reward vouchers with retailers. If you are confident you’ll be able to pay off your balance in full each month, this card is the right choice as they offer air miles, store credit and a lot more.

 

  • Interest-free Cards:

These credit cards are ‘interest-free’, that is they charge no interest on purchases for a limited time, often upto 27 months. If you’re planning to buy something costly like home appliances or make many small purchases, this card is most useful. However, with interest-free cards, you have to exercise self-discipline and put aside the borrowed amount to pay at the end of the 0% period. If you fail to pay in full, you may have to pay the reasonably high headline interest rate.

 

  • Cards for Bad Credit:

It’s okay if you don’t have a very good credit score. You can still get a credit card designed for people who are trying to rebuild or build (having never taken credit) their credit history. They start off with a very low credit limit (£150-£200) but the limit increases if you pay it back on time and show good credit behaviour. These credit cards often have a very high APR- from 25% up to 60%.

 

  • 0% Balance Transfer Card:

A 0% balance transfer card allows you to transfer a debt from an existing to your new credit card. You can then pay it off interest-free. You may be charged a fee on your balance transfer deal- typically 3% but some card providers charge 5%. The moment your 0% deal comes to an end, you’ll be charged interest at the card’s standard rate. So you should either repay the balance before this conversion or switch to another balance transfer deal.

 

  • Overseas Spending Cards:

These cards are the right choice for people who travel a lot overseas, either for work or just to enjoy a holiday. Often, other types of credit cards are charged high fees if used abroad. But, with a card specially designed for use in foreign countries, you pay no or low fees.

 

How useful are Credit Cards for Long-term Borrowing?

Sometimes we may have to swipe our cards for large sums of money. And we may not always have that much money in our current account. A credit card helps by allowing cardholders to use its credit facility to either pay for goods like furniture or services like a beauty salon bill. If you clear your debt in full each month, you don’t pay any interest. If you’re unable to, you can spread your payments over the coming months but at an 18% APR with most card providers. Therefore, you should pay off your credit card loan as early as possible. It’s great as a short-term fix but is costly if used for long-term borrowing.

 

Are there any Penalty Charges?

If you take out a loan and don’t pay on time, you’re liable to pay extra charges to your lender. Credit card providers follow the same principle. If you are forgetful of your payments and miss your payment deadline, you will have to pay penalty charges. This usually makes a bad impression on your credit file. You also have to pay penalty if you exceed your monthly credit limit so be mindful of how much you’re spending through your credit card.

 

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