Credit Cards

How do credit cards work?

Credit cards allow you to purchase goods and services on credit in a convenient and secure method, to be repaid on terms to suit your personal financial circumstances.

What are the advantages and disadvantages?

 Advantages include:

• Credit cards offer interest free borrowing where the balance is repaid in full by the appropriate due date.
• Credit cards enable you to agree a credit limit with a lender, and then draw down the balance in stages as and when required
• Credit cards offer a safe and convenient way to pay for goods and services both in the UK and abroad, particularly if you are purchasing over the internet, phone or by mail order, where there is a higher risk of fraud
• Under Section 75 of the Consumer Credit Act 1974, card issuers and retailers take joint responsibility for faulty purchases, therefore if you pay for something with a credit card, valued between £100 and £30,000, that turns out to be faulty, you can claim a refund from the card provider.
• Credit cards also offer protection against fraud.  For example, if you are the victim of fraud, and it is not your fault, you will not be expected to pay  any amounts resulting from the fraudulent use of your card by the criminal
• Credit card companies often offer various incentives for taking out and using a card such as loyalty points and cash back, in addition to the other incentives such as fraud protection discussed above
• Credit cards are accepted in virtually every country around the world, and are therefore perfect for taking on your holidays

Disadvantages include:

• Relatively high interest rates compared to some other forms of finance
• The flexibility in the rate at which you repay the outstanding balance can be a serious disadvantage if you end up repaying the minimum amount each month, and will result in you paying significant amounts of interest and taking a long time to pay off the balance
• The amount of finance available to you may be limited if you have not previously raised finance

Ways of Using a Credit Card

There are 3 main ways of using a credit card:

1. Making purchases
2. Transferring an outstanding balance from another credit card
3. Withdrawing cash

Costs of using you Credit Card

Each way the credit card is used attracts a different rate of interest.  In addition, payments made against the balance are posted against the balance attracting the highest rate of interest first, thus maximising the rate of interest you pay on the outstanding balance.

Some credit cards require payment of an annual fee.  To avoid paying this annual fee, you can opt for a credit card which does not require payment of an annual fee (there are many available on the market).

In addition to charging interest at the highest rate, drawing cash on your credit card also incurs a fixed costs for each transaction, typically around £2 - £3.