Credit cards are powerful financial tools that provide convenience, rewards, and flexible spending options, but they also require careful management to avoid high interest costs and fees. From understanding different card types and interest rates to mastering payment strategies, being informed is essential for making the most of your credit card while staying debt-free.
This guide covers everything you need to know about credit cards: the various types available, how interest and fees are calculated, and effective strategies for managing and reducing your balance. Whether you're looking to build credit, maximise rewards, or reduce your debt, this guide will help you use your credit card wisely and confidently.
By the end, you'll understand how to minimise interest costs, choose the right card for your needs, and take control of your credit card spending, so you can enjoy the benefits without the burden of costly debt.
1. What is a credit card?
A credit card is a convenient financial tool that allows users to borrow funds to make purchases, up to a set credit limit determined by the card issuer. Unlike traditional loans, credit cards offer revolving credit, meaning you can borrow, repay, and borrow again within your credit limit without needing to reapply.
Credit cards provide flexibility but require responsible management to avoid high interest charges and debt accumulation. Each month, you'll receive a statement that details your balance, minimum payment due, and any interest accrued if the balance isn't paid in full.
Credit cards are widely accepted and offer unique benefits, such as rewards and fraud protection, making them an essential part of everyday financial life for many. However, using a credit card wisely involves understanding its fees, interest rates, and terms to make informed financial decisions.
2. Types of credit cards
Credit cards come in a variety of types, each designed to suit different financial goals and spending habits. Some common types include:
Reward cards: - Offer points, cashback, or miles on purchases, which can be redeemed for travel, discounts, or other perks.
Balance transfer cards: - Provide a low or 0% introductory APR on balances transferred from other cards, helping you pay down debt at a lower cost.
Secured Cards: - Require a refundable cash deposit as collateral and are often used to build or improve credit history for those with limited or poor credit.
Low-Interest Cards: - Feature a lower APR than most cards, making them ideal for those who carry a balance occasionally.
Choosing the right type of credit card can help you optimise your spending and manage your finances more effectively. Consider your spending patterns, goals, and financial needs to select the most suitable card.
3. Rates of interest and fees
Credit card interest rates, often expressed as Annual Percentage Rates (APRs), can vary depending on the type of transaction you make. Different APRs apply to different actions, so understanding each one can help you manage your credit card use effectively:
Each APR type applies based on the specific transaction you make. Being aware of these rates enables you to use your credit card strategically to reduce interest charges. For instance, paying off your balance in full each month can help you avoid the Purchase APR altogether, while taking advantage of promotional balance transfer offers can reduce the interest you pay on transferred debt.
Purchase APR
The Purchase APR is the interest rate applied to everyday purchases made with your credit card, such as groceries, dining, or retail shopping, when you don't pay your balance in full by the due date.
Typically, this APR is lower than other types of APRs, such as cash advance APRs since it applies to regular transactions.
However, typically the costs can still add up if you carry a balance due to the rate of interest of on the card.
Typical rates: - 15% to 30% APR
Typical fees: - 2% to 3% of the amount for foreign currency advances
Cash advance APR
Cash advances let you withdraw cash from an ATM or bank using your credit card, but they come with high costs. The Cash Advance APR, often 25% to 35%, starts accruing interest immediately, with no grace period. This means interest is charged from the day of withdrawal until fully repaid, adding to the total cost.
Most credit cards also charge a cash advance fee, typically 3% - 5% of the amount withdrawn. For example, a £200 advance could incur a £10 fee upfront, plus daily interest charges until it’s paid off, making cash advances one of the most expensive credit card options.
Typical rates: - 25% to 35% APR
Typical fees: - 3% to 5% of the cash advance amount
Foreign transaction fees: - Typically 2% - 3% of the amount for foreign currency advances
Balance transfer APR
Many credit cards offer a Balance Transfer APR to allow you to move debt from one card to another. This can come with an introductory rate, sometimes as low as 0%, for a specified period (often 6 to 18 months). After the introductory period, the standard Balance Transfer APR applies. Be aware of any fees associated with balance transfers, typically a percentage of the transferred amount, and ensure you can pay off the balance before the promotional rate expires to avoid higher interest charges.
Typical balance transfer rates: - 0% to 3% APR,for a limited period of time.
Typical offer periods: - 6 to 36 months
Typical fees: - 3% to 5% of the cash advance amount
4. How is interest calculated
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.
Typical interest rates
Interest rates on credit cards can vary significantly depending on the card type, issuer, and your creditworthiness. Generally, they range from 15% to 30%.
Special categories, like balance transfers or introductory rates, may offer temporarily lower rates, sometimes as low as 0% for a limited period.
How credit card interest is calculated
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.
For more information on calculating interest, see our guide.
The interest-free period
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 maximise the benefits of using a credit card, such as rewards and convenience, without incurring extra costs.
5. Advantages of credit cards
When used responsibly, credit cards can provide a range of valuable benefits, helping you manage daily expenses, build credit, and even earn rewards. They are a versatile tool for achieving financial goals and can make everyday transactions more convenient and secure.
However, to fully enjoy these advantages, responsible usage is essential. Paying your balance in full each month allows you to avoid interest charges and prevent debt from accumulating. By viewing your credit card as a tool for financial empowerment rather than a source of debt, you can unlock its full potential and enjoy its many benefits with confidence.
i. Building credit history
Using a credit card responsibly by making on-time payments helps build your credit history and improves your credit score over time. A strong credit score can open doors to better loan rates, rental opportunities, and even job prospects, as many employers and landlords may check your credit as part of their decision-making process.
ii. Rewards and cashback
Many credit cards offer rewards programs, allowing you to earn points, miles, or cashback on purchases. These rewards can be redeemed for travel, gift cards, or even statement credits, providing extra value on everyday spending. Cashback cards, in particular, can help you offset monthly expenses by giving back a percentage of what you spend.
iii. Purchase protection
Credit cards often come with purchase protection benefits, such as extended warranties, return protection, and price matching. These features can provide peace of mind by covering repairs or refunds if an item is damaged, lost, or goes on sale shortly after purchase. Not all cards offer the same protections, so it's worth checking what benefits your card provides.
iv. Travel benefits and insurance
Certain credit cards offer travel perks such as airport lounge access, travel insurance, and no foreign transaction fees. Travel insurance may include coverage for trip cancellations, lost luggage, and emergency medical expenses, which can save you money and hassle during your travels. No foreign transaction fees are especially beneficial if you travel internationally, as they eliminate the extra cost of using your card abroad.
v. Fraud protection
Credit cards typically offer robust fraud protection. If your card is lost, stolen, or used without your permission, credit card issuers generally provide zero-liability protection, meaning you won't be responsible for unauthorised charges. This protection is a significant advantage over debit cards, where unauthorised transactions can sometimes take longer to resolve.
vi. Emergency access to credit
In times of unexpected expenses, a credit card can serve as a backup source of funds. While it's essential to avoid carrying a balance, a credit card can provide financial flexibility in emergencies or when cash flow is temporarily tight. Access to credit in these situations can be a lifeline if used prudently.
6. Disadvantages of credit cards
While credit cards offer many benefits, they also come with certain risks. Being aware of these potential downsides helps you make informed decisions and avoid financial pitfalls. Here are some common disadvantages of credit cards to consider:
Credit cards can be powerful financial tools but require careful management. By understanding these risks, you can take proactive steps to minimise them such as setting a budget, paying more than the minimum, and closely tracking your spending. With mindful usage, you can navigate common credit card challenges and maintain responsible credit habits.
i. High interest rates
Credit cards typically carry higher interest rates than other forms of credit. When you carry a balance from month to month, interest compounds on the remaining balance, making it easy for debt to grow quickly. This can lead to significant interest costs over time, especially if only the minimum payment is made.
ii. Encouragement of overspending
Credit cards provide easy access to funds, which can sometimes lead to overspending. Unlike cash transactions, where you see the immediate depletion of funds, credit cards can create an illusion of endless availability, making it tempting to spend beyond your means. This can result in unmanageable debt if not kept in check.
iii. Fees and penalties
Credit cards often come with various fees, such as annual fees, late payment fees, and balance transfer fees. Missing a payment can also lead to costly penalty APRs, which can be significantly higher than the regular rate. These fees and penalties can add up, increasing the cost of using the card.
iv. Negative impact on credit score
Mismanaging a credit card, such as making late payments or carrying high balances relative to your credit limit, can negatively impact your credit score. A low credit score can make it more challenging to secure favorable loan terms in the future. Responsible usage is crucial for maintaining a healthy credit profile.
v. Risk of debt accumulation
Credit cards make it easy to borrow against your future income, which can lead to accumulating more debt than you can repay. Debt can quickly snowball, particularly when you have multiple credit cards with balances. This can create a cycle of paying interest rather than reducing the principal, making it harder to become debt-free.
vi. Complexity of terms and conditions
Credit card agreements can be complex, with terms that are not always easy to understand. Different APRs for purchases, cash advances, and balance transfers, along with promotional rates and penalty fees, can make managing a credit card confusing. Misunderstanding these terms can lead to unexpected costs.
7. Purchase protection
In the UK, section 75 of the Consumer Credit Act 1974 provides credit card users with valuable purchase protection. This legal protection makes your credit card issuer jointly liable with the retailer if something goes wrong with your purchase, offering an extra layer of security for significant purchases.
Section 75 is one of the strongest consumer protections available to credit card users in the UK. By understanding how it works and the types of purchases it covers, you can use your credit card strategically for added peace of mind.
What is covered under section 75?
Section 75 covers purchases valued between £100 and £30,000, regardless of whether you pay the full amount on your credit card or only a portion. If the product or service is faulty, not as described, or if the seller fails to deliver due to bankruptcy, you can claim directly with your credit card issuer. This means that even if the retailer is unresponsive or unable to fulfill their obligations, your credit card company can step in to provide a refund or compensation.
How section 75 protection works
Section 75 protection is a statutory right, meaning it's guaranteed by law and cannot be removed or changed by the credit card issuer. Unlike purchase protection offered by individual credit card issuers (such as extended warranties or return policies), Section 75 consistently applies to all eligible credit card transactions, making it one of the most dependable protections for UK consumers.
PayPal
Section 75 only applies to direct purchases between you and the retailer. If you pay through a third party, like PayPal or a payment processor, you may lose this protection.
PayPal does have its own Buyer Protection program, but it doesn't offer the same level of coverage as Section 75 and may not cover all issues, like high-value claims or specific purchase disputes.
8. The minimum payment
Each month, your credit card issuer requires a minimum payment to keep your account in good standing and avoid late fees. While making only the minimum payment helps you avoid immediate penalties, it's essential to understand how different minimum payment calculations work and how they impact your balance over time.
Credit card companies may use different methods to calculate the minimum payment. Here are some common approaches:
Percentage of balance + interest: - This method calculates the minimum payment as a percentage of your outstanding balance plus any accrued interest, ensuring that a portion of the principal is paid down each month.
Percentage of balance: - The minimum payment is calculated as a fixed percentage of the balance, usually around 1-3%. While this lowers the payment amount, it may result in slower debt reduction.
Double the interest + fixed amount: - Some issuers calculate the minimum as double the monthly interest plus a fixed amount, like £10 or £20, helping to pay down the balance more steadily.
Fixed payment: - A set minimum payment, such as £25 or £30, regardless of the balance. This can be effective for smaller balances but may not reduce debt quickly for larger balances.
Be careful, only paying the minimum makes borrowing very expensive:
While minimum payments can help manage cash flow in the short term, consistently paying only the minimum means most of your payment goes toward interest rather than reducing the principal. This can prolong debt and lead to higher interest costs over time. Paying more than the minimum each month can significantly reduce the total interest paid and help you become debt-free faster.
Calculator:
Understanding how your credit card calculates the minimum payment is key to managing debt effectively. Check your credit card agreement or statement for specifics on the calculation method used, and aim to pay more than the minimum whenever possible to minimise interest costs.
Minimum payment settings
Enter balance (£):
APR (%):
Interest charges:
Time to repay:
What does this mean?
9. Overpaying your balance
We've seen that credit cards can become an expensive form of borrowing when only the minimum payment is made each month.
If paying the full balance isn't feasible, try making extra payments whenever possible - even small additional contributions each month can make a substantial difference over time.
Use our overpayment calculator below to see how overpaying your card can have a big impact.
Estimated interest saved:
Estimated time saved:
What does this mean?
10. Strategies for reducing your balance
If paying off your credit card balance in full each month isn't possible, consider strategies to reduce your interest costs. One effective approach is transferring your balance to a card with a 0% introductory APR.
Many balance transfer cards offer 0% interest for an initial period, giving you time to focus on repaying the balance without accruing additional interest. This can be an effective way to save on interest charges, allowing more of your payments to go toward the principal balance.
Before applying, check for any balance transfer fees and make efforts to repay the transferred balance before the introductory period ends, as rates may increase afterward.
With careful planning, a 0% balance transfer card can be a powerful tool in reducing your debt more efficiently.