How do credit cards work?
A credit card allows you to borrow money to spend on the spot. You’ll typically have topay back whatever you’ve spent monthly. Your spending limit is agreed on in advancewith the lender, as is the rate of interest on any money that you owe if you don’t payoff the balance. There are differenttypes of credit cards available.
Advantage: Protection
Under Section 75 of the Consumer Credit Act, the credit card provider will have theresponsibility of making sure that you’re reimbursed if you don’t get what youpaid for. For example, say you paid for a television using your card, and the company thatyou bought it from goes bust before you receive it – your provider should make sure that youget your money back. This typically applies for purchases between £100 and £30,000.
Disadvantage: Cash withdrawals
You may incur a charge whenever you use your credit card to withdraw cash, whether locally orabroad. This includes the use of ATMs and may extend to other uses, including buyingtravellers’ cheques and making payments to other accounts. Withdrawing cash (alsoknown as a cash advance) from a credit card can have a negative impact on your credit score.Lenders may look at this unfavourably as it can be an indication of poor money managementespecially if there are multiple cash advances in a short period of time.
There are other potential advantages and disadvantages of having a credit card. You can viewsome of these here.
Credit cards and your credit rating
You’ll be expected to make monthly repayments on your credit card spending, includingthe minimum monthly amount charged by your provider. It’s important that you rememberto pay this off as missed payments could affect your credit history – this could impact yourability to obtain credit if you’re planning to borrow money.
Having a credit card could be useful in helping you to obtain credit – if you use it enoughand make your repayments on time. This shows lenders that you’re able to makerepayments on credit repayments promptly, which could help boost your creditworthiness whenyou’re applying to borrow money, such as for a loan or mortgage.
Having a credit card and showing that you can use it responsibly might help toimprove your credit rating, if it’s poor. You may want to be aware, though,that your credit history will be assessed by the lender when you’re applying for acredit card – a good rating will typically help your application, and give you a chance atgetting better interest rates.
If you’re planning on applying for a credit card, you may want to view your Equifax Credit Reportand Score beforehand – it’s free for the first 30 days, then £14.95 monthlyafter that. The report will let you see if there’s anything in your credit historythat should and can be improved, while your score will give you an indication of yourcreditworthiness.
This article was updated in April 2021; all information was correct at thetime of writing.
