Good for:
Earning rewards and cashback
Building or improving credit history
Keep in mind:
High interest rates if not paid in full
Potential late payment fees
Can impact credit score if mismanaged
Credit cards offer convenience, rewards, and flexibility, but they also come with unique fees and interest. Understanding credit card types, rates, and payment strategies is key to managing balances effectively.
Each month, every £1 bond number is entered into a prize draw with chances to win tax-free prizes ranging from £25 to £1 million. There are no penalties for cashing in your bonds, making them similar to an easy-access savings account.
However, there's no guarantee of winning a prize, and your money doesn't earn interest while held by NS&I, which could lead to a loss of value over time. This guide will help you assess your options.
1. What is a Credit Card?
A credit card is a financial tool that allows users to borrow funds for purchases with a set credit limit. Unlike loans, credit cards offer revolving credit, meaning you can borrow up to your credit limit, repay, and borrow again.
Credit cards provide flexibility but require responsible management. Each month, you’ll receive a statement showing the balance, minimum payment due, and any interest accrued.
2. Credit Card Interest
Credit card interest is the fee charged by card issuers when you carry a balance from one month to the next. This interest is typically calculated daily and compounded monthly, based on the card's Annual Percentage Rate (APRAPR, or Annual Percentage Rate, reflects the yearly interest cost on a credit card. It includes both the nominal rate and compounding to represent the effective rate.). If the full balance is not paid by the due date, interest starts to accrue on the outstanding balance.
Credit card interest is generally calculated using the **Average Daily Balance** method, where the daily balance of your account is summed up over the billing cycle and divided by the number of days in that cycle.
To calculate the daily interest amount with compounding, the following steps are used:
- 1. **Daily Rate Calculation**: The APR is converted to a daily rate using this formula:
Daily Rate = (1 + APR)^(1/365) - 1.
For an 18% APR, the daily rate is approximately **0.0466%** (or 0.000466 as a decimal).
- 2. **Average Daily Balance**: Each day’s balance (after any transactions, fees, and payments) is added up and divided by the number of days in the billing cycle.
- 3. **Daily Compounding**: The daily rate is applied to the average daily balance over each day in the billing cycle, compounding as the month progresses.
Example: If your APR is 18%, your daily interest rate is approximately 0.0466%. If your average daily balance for the billing cycle is £1,000, the interest for that month with daily compounding would be calculated as follows:
- Calculate the daily interest rate: **0.0466%**.
- Apply the daily rate over 30 days, using the formula for daily compounding:
- Balance with Interest = £1,000 × (1 + 0.000466)^30 ≈ £1,014.20.
After compounding, the interest accrued over the month would be approximately £14.20, slightly higher due to daily compounding.
Many credit cards offer an **interest-free period** on new purchases, typically lasting between 21 to 55 days. This period allows you to avoid interest charges by paying off the full balance within this timeframe. The interest-free period applies only if you consistently pay off your balance in full each month. If you carry a balance from month to month, new purchases might start accruing interest immediately, without an interest-free grace period.
Key Points to Remember:
- To take advantage of the interest-free period, make sure to pay the full statement balance by the due date each month.
- If you carry any balance from a previous billing cycle, you may lose the interest-free period on new purchases until the balance is cleared.
- Cash advances and balance transfers usually do not qualify for an interest-free period and accrue interest immediately.
By making full monthly payments before the due date, you can avoid paying interest on your credit card. This strategy can help you maximize the benefits of using a credit card, such as rewards and convenience, without incurring extra costs.
3. Types of Credit Cards
Credit cards come in many varieties, each designed for different financial needs. Common types include:
- Reward Cards: Offer points or cashback on purchases.
- Balance Transfer Cards: Lower APR for transferring existing credit card debt.
- Secured Cards: Require a cash deposit and help build credit history.
4. Credit Card Interest Rates
Different types of transactions on a credit card can have different interest rates, including:
- Purchase APR: Charged on purchases if the balance is not paid in full.
- Cash Advance APR: Higher rate for cash withdrawals.
- Balance Transfer APR: Often has an introductory lower rate for balance transfers.
5. Annual Percentage Rate (APR)
APR, or Annual Percentage Rate, reflects the yearly interest cost on a credit card. It includes both the nominal rate and compounding to represent the effective rate.
6. Representative APR
The representative APR is the rate shown in advertisements and is applied to at least 51% of successful applicants. It helps you compare credit offers.
7. Minimum Payment
Each month, a minimum payment is required to avoid late fees. Paying only the minimum prolongs the debt and increases interest costs. Paying more than the minimum can reduce interest paid.
8. Overpaying Credit Card Balance
Overpaying your credit card balance reduces interest costs and the repayment period. Use our overpayment calculator to see how much you can save by paying more than the minimum.
9. Transferring a Balance
A balance transfer can help reduce interest costs by moving debt to a card with a lower or 0% introductory APR. Many balance transfer cards offer low rates for an introductory period, making it a useful tool for managing high-interest debt.