How do credit cards work?

How credit cards work

A credit card lets you borrow money - this is typically for spending on the card, but some let you transfer cash or existing credit card debt. You’ll need to pay the money back and may be charged interest, depending on when you pay and the type of card you have.

Before applying for a credit card it's important to work out how you want to use it. There are hundreds of deals on the market, and which is best for you will depend on your needs.

In this guide, we explain the different types of credit card, what you need to consider before you apply, the benefits of using a credit card and when you should avoid using a credit card.

What credit card should I get?

The right credit card depends on what you need it for – whether that’s clearing existing debt, spreading the cost of a purchase, or earning rewards. Here’s how different types of credit cards work:

0% balance transfer credit card 

0% balance transfer cards allow you to move debt from an existing card, which you can then pay off interest-free. 

This can help you save money and pay off your debt more quickly, as all of your repayments will go towards paying off the debt itself, rather than the interest. 

The longest 0% balance transfer deals currently on the market are 34 months. 

Most cards charge a fee to transfer the balance - typically around 3%. 

Generally, the longer the 0% the term, the higher the fee will be. This means it may be cheaper to choose a deal with a shorter interest-free period and a smaller fee, as long as you’re confident you can afford to pay off the debt within the timeframe. 

Most balance transfer cards charge a high rate of interest, so you should aim to pay off the debt before the 0% term ends. If you don’t you should consider switching to another 0% balance transfer card.

• Find out more: best 0% balance transfer cards​​​

Money transfer credit card

A money transfer credit card allows you to shift money from your card to your current account to spend as cash, usually for a transfer fee of around 4%.

These cards work similarly to balance transfer credit cards - but the difference is that balance transfer cards only allow you to shift debt between credit cards.

This type of card could help you clear an expensive overdraft or payday loan or get an interest-free loan for cash-only purchases.

If you held an 18-month 0% money transfer card with a limit of £2,000, you could request a £1,000 money transfer to your bank account - at a typical 4% fee, you would owe £1,040 on your credit card and have £1,000 in your bank account to spend straight away. You would have more than a year to clear the credit balance before interest was charged.

• Find out more: best money transfer cards

Interest-free purchase credit card

0% purchase credit cards allow you to spread the cost of spending over a set period of time, without being charged interest. 

The longest deals on the market currently offer 25 months interest free.

These cards are perfect for spreading the cost of a large purchase, or for making lots of smaller ones, over the interest-free period.

You’ll need to repay the debt steadily or make sure you have enough money set aside to pay off your card before the interest-free period ends. Otherwise, you’ll be charged interest on the remaining balance, which is typically around 24%.

• Find out more: best interest-free purchase cards

Credit builder card

Credit-builder cards are for those trying to rebuild their credit rating (or build one up if they have no credit history).

If you get one of these cards, you should always pay off the bill in full every month as they often have a very high APR - anywhere from 29% up to 40%. They tend to have a 'low and grow' approach, whereby your initial credit limit is very low (say £100 to £200), but increases as you prove you can manage it responsibly.

• Find out more: best credit cards for bad credit

Cashback and reward credit card

Cashback credit cards allow you to earn a percentage back on what you spend. This money is paid as a credit on your account monthly or yearly.

Cashback rates typically range from 0.25% to 1%. Some of the best deals on the market offer introductory rates of up to 5%, although the amount of cashback you can earn is often capped over this period.

Reward credit cards differ from cashback credit cards by giving you points that you can redeem against goods and services, or convert into reward vouchers with a particular retailer.

Air mile credit cards let you earn points on your spending that can be redeemed on flights and travel. 

The best way to use these types of credit cards is to avoid borrowing and pay off the balance in full every month, as they generally have a high APR.

• Find out more: best cashback and reward credit cards

Travel credit card

Most credit cards add a foreign transaction fee of around 3% on non-sterling purchases and cash withdrawals. But specialist travel cards don’t charge these fees, making them a much cheaper option for spending abroad.

When using your card abroad, always choose to pay in the local currency rather than pounds to get the best exchange rate. You should avoid borrowing on these cards, as the APR can typically range from 19% to 34%.

• Find out more: best travel credit cards

Low-interest credit cards

Credit cards with a low standard interest rate (a low APR) make the headlines, but these aren't necessarily the best cards for everyone. For most people, a card for one of the specific uses above is probably a better deal.

This type of credit card is worth considering if you're likely to use it infrequently and won't always pay off the bill in full.

But watch out. Banks and credit card companies tend to use your credit history to set interest rates on their credit cards. This means that those with a poor credit history are generally offered a higher interest rate when they apply.

• Find out more: best low-interest credit cards

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What to consider when applying for a credit card

We outline the key things to weigh up before you go ahead with an application.

Is more debt right for me?

Before you take out a new credit card, it's important to carefully consider whether taking on extra debt is manageable - both in the short and the long term. 

Our credit card repayment calculator can help you work out how much your credit card debt will cost you, and when you will clear it.

Is a credit card the right option?

It’s also worth considering if there are more affordable forms of credit available to you.

Check if your current account has a fee-free overdraft that will meet your spending needs.

For smaller loans, you could consider a credit union. As non-profit financial organisations, they usually offer loans that are cheaper than other providers and that don't incur fees.

If you need to borrow a larger amount, a personal loan may be a better choice. Unsecured personal loans are usually a cheaper option and you will have a fixed monthly payment until the loan is paid off.

Check your credit score

It's a good idea to check your credit score regularly as those with the best scores get offered the best deals.

Your credit score will affect your credit limit (how much you will be able to borrow), how long any introductory deals will last and the interest rate you'll be charged.

You can check your credit score for free online and some credit reference agencies will even give you tips on how you can improve it.

• Find out more: how to check your credit score for free

Check your eligibility

When you apply for a credit card it will leave a mark on your credit file, so if you apply and you are rejected, it will be more difficult to get a card in the future.

This is why it's always best to check your eligibility first. Most credit card providers will have an option to do this on their website beforehand - in this case, they carry out a 'soft search', which does not impact your credit score.

Is it a good provider?

You want to find the best deal, but it's also important to know if the company behind the offer will provide decent customer service if something goes wrong.

Every year, we survey thousands of credit card holders to find out how satisfied they are with their provider, and our experts analyse the best deals on the market to find out which providers are cream of the crop.

Check out our guide to the best credit card providers to find out which brands were named Which? Recommended Provider.

The benefits of using a credit card

Here are some of the key benefits that might make a credit card a useful addition to your financial toolkit.

Protection under Section 75 and chargeback

If you use a credit card to pay in full or partly for goods or services costing between £100 and £30,000, you get valuable protection under section 75 of the Consumer Credit Act. 

Under Section 75, your credit card provider is jointly liable with the retailer if something goes wrong, meaning you can claim a refund if you get faulty goods or your item never arrives. Section 75 applies even if you only put part of the cost on your credit card.

Even if section 75 doesn't apply, for example, if the total cost of the purchase is less than £100 or more than £30,000, you may be able to put in a claim under the industry-agreed chargeback system.

Credit building

Credit card borrowing shows up on your credit report. 

Regularly repaying credit card debt on time will improve your credit score, which may help you access better credit deals or other forms of borrowing, such as a mortgage.

Some credit cards are designed specifically to build your credit rating, which can be useful if you have a poor score or limited credit rating. 

Help spread costs

When used wisely, a credit card can be an affordable and convenient way to spread the cost of larger purchases. 

However, it’s essential that you choose the right card and make sure you use it properly: always repay in full each month or before your 0% period ends to avoid racking up hefty interest charges.

When you should not use a credit card

Some credit card transactions, such as buying foreign currency, can come with unexpected fees and fewer perks.

Paying for foreign currency

If you want to buy foreign currency before you go on holiday, don't pay by credit card - not only will your card provider charge you a cash advance fee, most will also charge you a higher APR and you won't get an interest-free period, even if you repay your bill in full and on time.

The same can go for buying gift cards and vouchers.

Withdrawing cash

Cash withdrawals attract a withdrawal fee, as well as a higher APR, and don't enjoy the interest-free period available for other types of spending.

They are also recorded on your credit report and can be viewed by lenders as a sign of financial stress, something that could affect your ability to get credit.

Third-party payments

Using your credit card with third-party payment systems can mean you'll lose important Section 75 protection on items that cost more than £100.

Section 75 protection only applies if there’s a clear link between you, the creditor and the retailer. Using a third-party payment system can break this chain, meaning you’re not covered.

For example, if you use your credit card to add funds to your PayPal account or Google Wallet and then make a purchase, you won’t be protected.

Similarly, you won’t be protected if you use your credit card in conjunction with ‘Buy now, pay later' schemes such as Klarna, and Clearpay, or from third-party sellers on Amazon.

Paying by credit card cheque

Credit card providers aren't allowed to send unsolicited credit card cheques anymore, but if you've got any hidden in a drawer or if you've opted into receiving them, shred them now.

Section 75 cover never applies to credit card cheques, and you'll have to pay a fee to use one.

If you can’t afford the repayments

If you're considering taking on more debt because you're struggling to make ends meet, it may be worth exploring other resources.

Firstly, make sure you're maximising your household income with all of the financial support you're entitled to. Resources such as Turn2us can help you find government benefits, grants, and other schemes you may be eligible for, depending on your situation.

If you’re struggling with debt, organisations like StepChange and Citizens Advice can provide free and non-judgmental advice to help you get your finances back on track.

• Find out more: free debt advice contacts