What Is A Credit Card?

We use these plastic or metal cards with magnetic strips to make purchases on ‘credit’.

Updated: November 27, 2023
Matt Crabtree

Written By

Matt Crabtree

 

Have you ever watched someone tap a small plastic card when you're at the till, ready to pay for something?

If so, chances are they were using a credit card. Let's be honest, credit cards have become a fairly ubiquitous presence in our daily lives, and this is only reinforced by the rise of online shopping and retailers that only accept card payments.

Still, despite using one of these financial tools at many points in your life, have you ever considered what exactly they are and how they work? Extending to all corners of your financial life, having a stronger understanding of what's actually happening when you're making credit card purchases can be incredibly useful.

But with all the various options to choose from and confusing jargon from your credit card provider, how can you avoid being overwhelmed?

In this article, we aim to arm you with the basic knowledge needed to navigate the world of credit cards with a clear head, understanding what makes each type of credit card useful and avoiding falling victim to any sneaky fees. From credit scores to interest rates, we'll be breaking down all you need to know to get by.

So, whether you've already got some experience with credit cards or you're looking to apply for your first one, let's get started!

Understanding Credit Cards

Like most people, there's a strong chance you've already got a basic understanding of a credit card, perhaps even owning one or two yourself.

Still, there are numerous benefits for you as a credit card holder when you invest some time in learning more about them.

In this first section of the article, we'll be building on your current understanding of credit card providers, with the ultimate aim of helping you manage your finances better.

Definition

Let's start with the basics. In essence, credit cards are a kind of financial tool that allows you to borrow a prearranged amount of money from either a bank or financial institution, allowing you to make payments like normal.

Whenever you're using one of these cards to purchase something, you're basically borrowing money from whichever bank issued you the card, meaning you've got to pay it back, plus interest, at a later date.

Now any time you're issued a credit card, it'll always come with what's known as a credit limit — the maximum amount of money you're able to withdraw from your card at any given time.

Before providing you with your card, the financial institution will work out what credit limit to assign you based on a few factors, like your credit score, credit history, income, and various other miscellaneous information.

How Do Credit Cards Work?

With some added context to your previous understanding of credit cards, let's take a look at how they actually work. Essentially, whenever you make a payment with one of these cards, the bank pays the merchant on your behalf.

Naturally, this isn't without an applied interest rate, so you'll always have to pay the bank back with an extra charge.

We'll delve into more detail shortly, but these kinds of cards can be incredibly valuable for making cashless payments, not to mention the impact responsible spending can have on your credit score (helping you receive a more favourable credit limit in the future).

Still, it's worth mentioning the inherent risk that comes along, too, not least the potential to stack up debt if used irresponsibly. In addition, high interest rates and the annual fee can be frustrating to budget around.

How Do They Compare To Other Payment Methods?

Ever wondered what makes cards different from other kinds of payment methods, like a debit card or cash? Obviously, there's a stark difference when it comes to cash — being the most straightforward and simple way to pay for things in your everyday life.

Still, traditional notes and coins naturally don't offer the same benefits you'd expect with a credit card, such as gaining reward points or boosting your credit score.

Debit cards, on the other hand, share many more similarities with credit cards in that they allow you to make purchases without cash. The only difference is debit cards are tied directly to your bank account, meaning you'll never be able to spend outside of the balance you've currently got in your account.

While this can be fairly useful when looking for a convenient alternative to cash that can help you avoid debt, you won't actually be able to borrow money from a financial institution or bank.

What Are The Various Types of Credit Cards?

In this next section, we'll go over some of the more mainstream options at your disposal when looking to apply for a new card. Each card comes with its own unique set of pros and cons, so we'll give each option a fair analysis to help you make a more informed decision.

Kicking things off, let's talk about what makes a rewards credit card special.

Rewards Cards

Among all the different types of credit cards, rewards cards are constantly in demand for their numerous benefits provided to cardholders — things like cashback, points, or miles every time you make a payment with the card can be a great way of reducing your overall credit card balance and saving some money.

With these rewards, you'll be able to receive various bonuses, like a discount on your next international flight etc. Depending on who your rewards credit card issuer is, you might also be able to get travel insurance or even some form of purchase protection.

Still, these cards aren't without their drawbacks, with high annual fees and complicated reward structures being among some of the biggest complaints from cardholders.

Similarly to before, the rewards rates for different purchase categories might change depending on your card provider, as well as the risk of your rewards expiring.

Secured Credit Card

For anyone with a specific interest in building or rebuilding their credit, these cards can be a fantastic asset, providing you've got the collateral to back it up. Secured credit cards require some form of security deposit up front to act as a form of protection on the card issuers' behalf.

Because these cards are normally aimed towards people with less favourable credit scores, the bank or financial institution has to compensate for the added risk that comes with a low credit rating. In this case, the risk is the potential of the user defaulting on their payments.

Since the card issuer has a form of collateral (normally a car, jewellery, or any other valuable item) to minimise the risk on their end, they're often willing to approve a person with any kind of credit rating.

Despite this lifeline for many people, it's worth noting that these cards can come with fairly high-interest rates and fees, especially compared with the credit card providers that only accept high credit scores.

And, since you've got to put down some form of deposit for the banks' protection, there's an unavoidable upfront investment that might not be possible for everyone to commit to.

Store Credit Cards

These are slightly more niche options, but store credit cards are a payment method that's only offered by specific retailers. Though you can only use them at a particular retailer or chain of stores, these cards still offer various discounts and special financing options that might be worth considering if you're trying to ditch cash.

Naturally, these cards aren't without their pitfalls either, with their lack of versatility being an obvious concern for frequent shoppers.

Travel Cards

Do you travel often for work or even just for pleasure? If so, travel cards are designed directly for someone like you, providing holders with various benefits like airline miles or hotel points.

In addition, they might even offer perks like airport lounge access or waived foreign transaction fees.

Although these are similar to rewards cards, those tend to focus on a wider range of goods, in comparison with travel cards that focus strictly on travel benefits. For those who travel frequently, it goes without saying that these benefits can add up quickly.

However, travel cards aren't particularly cheap to keep up, and there might be certain restrictions on how your rewards can be redeemed depending on your card issuer. And, of course, if you're not actually travelling very often, these cards may not be worth the cost of maintenance.

Balance Transfer Cards

Designed to help people consolidate their debts, these credit cards are a game changer for anyone with a high-interest balance across multiple different credit cards. In essence, these cards can be used to collate all of your existing balances, allowing for balance transfers to a new card with much lower interest rates.

You'll mostly find that these cards provide their users with a 0% APR introductory period; you don't need to pay interest for a certain time period (usually around a year).

Naturally, that's a massive plus for anyone feeling overwhelmed with their current state of debt, offering an opportunity to pay off their balance without accruing any additional interest charges along the way.

Still, like all of the other options on this list, there are inevitably going to be some fees involved when it comes to credit cards. In this scenario, there's usually a 3-5% charge of the total amount you're transferring over.

In addition, there's a stark jump in the interest rate after the introductory period finishes, so make sure you've got a plan in place to pay off your balance before this happens.

Pros & Cons Of Using A Credit Card

Although we've discussed the benefits and drawbacks of a few specific credit cards, let's take a broader look at credit cards as a whole — are they actually worth the hassle, or are there too many unappealing features about them?

Pros

Building Credit ✔️

Primarily, people of all ages tend to use credit cards as a way of establishing and improving their current credit scores. We've referred to credit score a lot during this article, but for clarity, this simply refers to a numerical value used by financial institutions to monitor your creditworthiness.

This type of thing plays a big role in how easily you're able to obtain various financial products, like loans or credit cards, for example. If you're making timely payments and keeping on top of your monthly statement, these cards can be an excellent means of streamlining your borrowing process in the future, regardless of the reason.

Rewards Programs ✔️

As mentioned already, whether it's with a travel, store, or rewards credit card, there's a huge opportunity here for stretching your money and saving a few pounds along the way.

Depending on the specific card you opt for, you can expect things like cashback, points, or miles whenever you make a payment with their card.

So, if you're planning on using one of these cards for your everyday expenses, like food shopping, it's worth applying for one of these cards to take advantage of things you were going to buy anyway.

Convenience ✔️

Perhaps most importantly, consumers generally find credit cards as a far more convenient means of making payments for any goods and services. For one, you obviously can't make online payments with cash, so credit cards open up a whole new opportunity for purchasing anywhere in the world, not just with cash on your local high street.

Additionally, these cards are required to follow the consumer credit act, meaning you'll be protected for any payments that you make up until a certain amount of value. Not only this but you'll be prevented from fraud, too, with the opportunity to dispute any unauthorised charges should they appear.

Cons

Potential Debt ❌️

One of the biggest reasons people decide to opt for a debit card to make their everyday purchases over a credit card is the implied debt that comes with the latter.

Obviously, you'll become in debt to the bank if you end up spending more than you can afford to repay, and it doesn't stop there — interest charges will accrue on any unpaid balances, so the longer you carry this balance, the more interest you'll end up paying.

While some financial products, like balance transfer cards, can normally offer a 0% interest period at the beginning of your term, many of these credit cards aren't so charitable, with high-interest rates making paying off your balance a stressful and anxiety-inducing experience.

High-Interest Rates ❌️

To continue, the interest rates you'd typically expect with a credit card are substantially higher than most other types of loans. As such, it's paramount that you make wise financial decisions to ensure you're never in a position that might lead to a debt cycle.

High-interest loans are notorious for disrupting the average person's financial life, so it's crucial to remind yourself of options like the aforementioned balance transfer card to help mitigate any stress.

Fees ❌️

And finally, we mustn't underestimate the impact of things like late fees and cash advance fees on your short-term finances whenever you're using one of these cards. Naturally, these types of fees can creep up on you without even realising them, and it ultimately makes the cost of using a credit card seem slightly unsustainable.

Remember, regardless of the credit card that you decide on applying for, just make sure to assess all the fine print as clearly as possible and to know which fees are applied to what.

How To Choose & Use A Credit Card

Throughout this next section, we'll be focusing more on how to decide which credit card best fits your needs and financial situation, as well as sharing a few easy practices for using your card responsibly and avoiding debt.

Selecting Your Credit Card

When you're looking to make the first step in selecting your credit card, it's vital to give your current financial situation a proper evaluation so you can avoid certain cards and consider others. Make sure to ask yourself a few questions:

  • What type of rewards do I actually want? Cash back, travel points, or something else?
  • What's my current credit score? Most credit cards require at least a “fair“ credit rating, while others, such as a secured credit card, might be available to those with lower scores.
  • How much do I plan on using the card, and what's the maximum amount I'm able to pay off each month?

Once you've put a few of the basics to one side, you're now in a much better position to begin researching and comparing different credit card options, knowing that there are certain options you can avoid looking at entirely.

Remember to select the card that most aligns with your personal circumstances, like cash back on your food shopping or travel rewards if you frequently fly.

Using A Credit Card Responsibly

Once you've chosen the credit card that best suits your needs, there are a few things you should keep in mind when it comes to responsible spending and credit building. There are plenty of ways you can use a credit card irresponsibly without even knowing, so it's best to brush up on a few good practices before starting the application process.

Pay All Your Bills On Time

We've covered this briefly already, but it's worth reiterating the importance of avoiding late payments if you're trying to avoid credit card fees and a knock on your credit score. Having said this, it's important not to take the opposite approach and pay off your loan too early either.

Depending on the financial institution that issued your loan, there may actually be an early payment penalty as well, so it's always important to double-check what fees are associated with your card regarding payments.

Pay In Full

Ideally, you should aim to pay your balance off in full every month to avoid accruing interest charges. We say “ideally”, as things like the aforementioned early payment fees can stop you from doing this in some cases.

Obviously, the bank or financial institution is more inclined to keep you paying their high-interest rates for as long as possible, so it's in their interest to stop you from paying your balance in full every time. Still, if you're able to, it's definitely recommended for the best chance of avoiding debt.

Using Your Credit Card Wisely

Remember, although you can see the maximum amount of credit you can make withdrawals with, don't be tricked into thinking this is your money or that it's a target to spend it all. Try to only use the card for purchases that you can afford to pay off quickly, and especially try to avoid it for cash advances or other high-interest transactions if possible.

Monitor Your Account

Errors can happen all the time, and they're normally very simple to resolve, but it's only you that will suffer if you fail to recognise any glaring errors or fraudulent activity on your monthly credit card statement.

Additionally, try to make a point of keeping a low credit utilisation ratio with your credit card. If you're unfamiliar, this refers to the total amount of credit that you're using in comparison to the amount you have available in your credit limit.

This is one of the driving factors that creditors use when adjusting your credit rating, so aim to use no more than 30% of your total funds to avoid appearing overextended to lenders.

How To Dispute Incorrect Credit Card Charges

For some additional context on this matter, let's discuss the proper protocol to follow in case you do happen to find any fraudulent or otherwise incorrect charges on your credit card statement.

Fortunately, this is actually quite a simple process that ultimately protects your finances when followed correctly, so don't stress too much if you see something out of place in your bank account.

1. Review Your Statement Carefully

First things first, know what you're looking for. Give your monthly statement a thorough check to see if there are any charges that appear outlandish or you don't recognise, and make sure to keep note of the date and total amount of the charge.

If you're struggling to remember the details of a specific charge, try to think back to where you were around the time of the purchase being made.

Obviously, if you were in the house all day and you noticed a transaction made in the city centre, there's something amiss. While this is slightly more specific advice, you might also want to check with any authorised users on your account to see if it was them who made the purchase.

2. Contact The Merchant

If you believe that one of the charges on your credit card statement is undoubtedly incorrect, the next step is to contact the merchant, normally possible via phone or email. Be sure to have your card statement and any other relevant receipts at hand when you're in contact with them, as that'll help you make your case with more confidence.

While you're speaking to the merchant, try to give a detailed account of what has happened and supply them with any evidence you might have to support your claim. While in some cases the merchant may be able to resolve the issue with you directly, you might need to take further action if they're unable to offer any help.

3. Disputing The Charge With Your Credit Card Issuer

So, what can we do if the merchant is unable to lend a hand in your plight? Well, next up is to go directly to the source, contacting your credit card provider directly.

Naturally, this is something that happens fairly frequently, so most of the established credit card issues will have a process in place for this kind of thing already — something you can start pretty easily online or over the phone.

As with the shop merchant, make sure you're able to provide your card issuer with any information that might help dispute your charges, like documentation or any correspondence you have with the merchant.

After this, your card provider will start an investigation into the dispute and might even issue a temporary credit to your account to get you by while the investigation is live.

4. Follow Up With Your Credit Card Issuer

Now that you've successfully begun your dispute, it's vital to perform regular check-ups with your card issuer to see how your claim is progressing. Around this stage, you might be asked to provide them with a few more pieces of information, so it's important that you do so promptly to keep the ball rolling.

Be sure to keep with any correspondence related to the dispute, too, meaning things like dates, times, and the names of any company representatives you speak with.

5. Double Check Your Credit Report

At this point, you've hopefully heard back from a representative to let you know the dispute has been resolved. Still, it's vital to run a credit report just to ensure that the incorrect charge has been removed and that your credit utilisation hasn't been impacted either.

You can request one of these reports from one of the three major credit reporting agencies. If you're still spotting errors or any discrepancies in your report, it's crucial to dispute them again as soon as possible.

Security & Fraud Protection

In today's digital age, credit card fraud and identity theft are growing concerns for consumers. Luckily, credit card companies are taking action to protect their customers' financial security.

In this article, we'll explore how credit card companies protect you from fraud and identity theft and the various security features they use to safeguard your transactions.

Chip Technology

One of the most significant advancements in credit card security in recent years is chip technology. Also known as EMV, these kinds of cards have a small microchip embedded in them to encrypt all your information, making it much more difficult for hackers to access your data.

This encryption technology is far more secure than the traditional magnetic stripe, which is easier for thieves to clone.

Additionally, chip-enabled cards require a unique authentication code for each transaction you make, so there's an additional layer of security every time you spend. Even if a hacker were to steal your credit card information, they would be unable to use it for any future purchases without the unique code generated by the chip.

Two-Factor Authentication

2FA is another popular security feature used by credit card companies. Similarly to before, these features make the user require at least two separate forms of identification before allowing access.

For example, whenever you log in to a certain online account, you may be prompted to enter a password and then provide a code that's sent to your phone via text message.

This added layer of security helps to keep unauthorised access out of your account, even if someone has obtained your password. If someone attempts to log in to your account without your authorisation, they will be stopped in their tracks and unable to access your account.

Related Guides:

FAQs

Do annual percentage rates (APRs) on credit cards tend to be stable or unstable?

What is a credit card's annual fee?

How can I establish credit in order to apply for a credit card?

What's the minimum payment on a credit card?

What fees should I be aware of when using a credit card?

What is a cash advance?

What do I do if I can't make my credit card payments?

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