Why should I get a credit card?
Consumer debt is at its highest level since the 2008 financial crisis, yet the reason for this is that so many of us need credit to keep up with the UK's cost of living.
From making more significant purchases to giving yourself options in case of an unexpected expense before payday, credit cards are unsurprisingly one of the best ways of obtaining a bit of extra money, yet they're also useful even if you don't need a loan.
As the following guide will make clear, they come in various shapes and sizes, and they have various uses. And as with most finance-related items, the kind of card that's best for you will all depend on your personal circumstances.
What is a credit card?
This may sound like a silly question, yet credit cards are a little more complicated than the simple term "credit card" would suggest. That's because a credit card isn't just a piece of plastic you carry in your wallet, but an agreement between you and your bank.
As part of this agreement, your bank agrees to lend you money under certain terms and conditions, while you agree to pay this money back according to those same terms and conditions.
For the most part, this means that you agree to repay a minimum of what you spend via your credit card each month. This minimum can vary from bank to bank, yet generally it's equal to anything from 1% to 5% of the balance (the amount owed).
With Lloyds, for example, you agree to pay an "amount equal to the total of interest, default charges and 1% of the balance shown in your statement (minimum £5, or the full balance if less than £5)".
Here, a customer who owed £20 would have to pay at least £5 at the end of the month, assuming that she had no interest to pay off, and that she had no default charges (penalties for late payments) to her name. If she didn't pay it off, she'd be liable for a £12 default or late payment charge, which are also liable for interest if they're not repaid in time.
Of course, it's utterly vital to point out here that you ideally should pay off everything you borrow each month. Otherwise, you'll be charged interest on your balance (often 18.9% APR), assuming that you're not within an introductory period that grants you 0% interest on purchases.
However, just so no one has nightmares about borrowing tens of thousands of pounds and then racking up mountains of interest, credit cards also come with maximum (as well as minimum) credit limits, although the exact value of these is generally "subject to status".
This means there's no typical or average figure, although maximums are likely to be in their hundreds if you're applying for a credit card for the first time.
What kinds of credit cards are there?
In view of these introductory remarks, it could be said that a credit card is basically a token of your agreement to borrow up to £X a month and to pay off this amount - or at least a minimum percentage of it - before the month closes.
That much is true, yet there are also different kinds of credit cards available, all of which hint at the different uses they can have.
Purchase credit cards
To begin with, there are interest-free or purchase credit cards. As the names suggest, they enable customers to make purchases without incurring any interest, often via an introductory offer that can last for as many as 29 months.
This means that holders can, for example, buy a £100 pair of shoes on credit, and then go 29 months without incurring any interest on the debt they owe on this purchase. They'll have to repay only £100, although it's important to remember that if they still owe money on this £100 after the 29 month period ends, they'll begin having to pay interest on it.
Yet still, the duration of such interest-free periods show one of the main benefits of having a credit card, which is the ability to purchase items that you wouldn't have been able to purchase otherwise.
With a (purchase) credit card, you'd be able to pay for holidays or new electric appliances over an extended period of time, paying off your debt gradually without racking up any extra debt in the form of interest.
|Purchase credit cards|
Balance transfer credit cards
And even if the interest-free period of a credit card is about to end, customers have the option of transferring their debts to a balance transfer card.
This is a type of credit that charges 0% on balance transfers, meaning that cardholders will continue to pay 0% on an outstanding debt, even though this debt came from an older card.
Once again, the interest-free period on balance transfer credit cards will inevitably come to an end, yet in comparison to purchase cards, this period is considerably longer. With the MBNA Platinum Credit Card, for example, it last 43 months, thereby giving customers this period of time to repay a debt without having to pay any interest on it.
In theory, it would be possible to repeatedly transfer outstanding balances from one card to another. However, this would still incur a cost, since all banks require that you pay a fee to make a transfer, a fee which usually ranges between 3% to 5% of the balance.
This means that, if you owe £1000 on a card, transferring it onto the aforementioned MBNA balance transfer card (at 3.29%) would cost £32.29. This is pretty cheap as a one-off payment, but if it were repeated three, five or 10 times, you'd end up paying £97.17, £161.95 or £323.90 overall, amounts which kind of defeat the purpose of repeatedly transferring a balance.
As such, while balance transfer cards enable you to borrow bigger amounts and make bigger purchases, they're not to be abused, since they come with their own costs.
|Balance transfer credit cards|
Credit cards for bad credit
But as good as balance transfer and purchase cards are for people who need a little extra spending money, the chances are that, if you're applying for your first ever credit card, you won't be successful in your application for either of them.
This is simply because you'll have little or no credit history, which makes banks wary of lending considerable sums to you. As a result, your best bet will be to apply for "bad credit" credit cards.
With such a card, you'll be able to improve your credit record and borrow money even if you actually have a poor credit history, since the terms of these cards are more restrictive and cautious.
For example, the Barclaycard Initial credit card comes with a purchase interest rate of 34.9% APR, which is considerably higher than the rates you'd receive with other cards.
Not only that, but the spending limit is generally very conservative, ranging from £1,200 per month at its highest to a low of £150.
While £150 might seem like a disappointingly small amount for some people, the important thing to remember is that the main point of such cards isn't really to loan money. Instead, it's to build up your credit rating, so that in the future you're more likely to approved for personal loans or mortgages.
It's for this reason that it's important to borrow only as much as you can fully repay each month, so as not to risk harming your credit rating. This is also important because, as an interest rate of 34.9% would suggest, you're liable to owe much than what you initially borrowed if you fail to pay off your balance at the end of each month.
|"Bad credit" credit cards|
So what can I use a card for exactly?
While the above overview of the main kinds of card provides a basic outline of some of the things credit cards can be used for, it would be helpful to provide a more explicit summary, as listed below:
To afford certain larger purchases, such as holidays and electronic appliances
To borrow money without having to owe any interest
To build up your credit rating, so that you're more likely to be approved for a mortgage, rental application or personal loan
To earn modest amounts of cash on purchases with cashback credit cards
To provide yourself with greater security when purchasing items online
This last point is an important one, since even though credit cards may have something of a bad reputation compared to debit cards, they're actually safer than the latter when it comes to purchasing items online.
Simply put, this is because it's the bank's money that's being spent when you buy something online, rather than your own money (which is what's spent with a debit card). As such, if you become the victim of fraud when spending with a credit card, your bank is much more eager to get the corresponding money back.
This eagerness is expressed in how credit cards are automatically covered under Section 75 of the Consumer Credit Act, which makes credit providers just as liable as the providers of goods and services.
This therefore grants cardholders the right to get their money back if something goes wrong with any purchase above £100, be it a complete failure to deliver it or the bankruptcy of the seller.
Such coverage isn't available for debit cardholders, who often have to fight with their bank and go through a laborious claims process to retrieve their money.
As listed above, people can also earn money with certain credit cards, also known as cashback credit cards.
Such cards reward you with anything between 0.5% to 2% on all purchases, although to make them work you have to ensure that you pay off your balance each month and avoid any interest charges.
Creditworthiness in an expensive age
Nonetheless, even with a shrunken market for cashback cards, credit cards still offer numerous benefits.
And, as the Bank of England's warnings about household debt suggest, credit is as plentiful and accessible as it's been for a long while.
With the credit available from a credit card, customers can afford purchases that would remain out of their reach otherwise, and they can do so without having to pay any interest, as they would with a payday loan.
Yet added to this, credit cards offer increased protection when shopping online. Most importantly, they're vital for those wanting to build up their credit rating in preparation for renting an apartment or buying a house.
They prove that people can be trusted with bigger loans or with paying the rent on time, and in an era when the cost of living is so high, such proof will only become more vital with the passing of time.