How do credit cards actually work?

A credit card used one way is a free short-term loan with strong purchase protection. Used another it is expensive borrowing. The difference is entirely whether the statement balance is cleared in full each month.

What you'll need

• Your card statement (optional)

Step by step

1. Understand the interest-free period.Purchases are interest-free until the payment date if you clear the full statement balance. That can be up to about eight weeks depending on timing.
2. Know what happens if you pay less than the full balance.On most cards, interest applies to the whole balance from the purchase date, not just the unpaid part. This surprises people.
3. Set up a direct debit for the full balance.It removes the risk of forgetting, guarantees no interest, and avoids late payment marks on your credit file.
4. Understand why minimum payments are expensive.They are set low, often around 1-3%. Paying only the minimum can take decades and cost several times the original balance.
5. Avoid cash withdrawals on a credit card.They usually attract a fee and interest from day one, with no interest-free period. It is one of the most expensive ways to get cash.
6. Use the purchase protection deliberately.In many countries credit card purchases above a threshold carry statutory protection making the card provider jointly liable. It is a genuine benefit for large purchases.
7. Watch for the end of promotional periods.0% offers end on a specific date, after which the standard rate applies to whatever is left. Diarise it.
8. Keep utilisation low.The proportion of your limit you use affects your credit file. Below about 30% is treated favourably, even if you clear it in full.

Tips

• Using a credit card for everything and clearing it monthly can build a positive credit history and earn rewards at no cost, provided the balance is always cleared.
• Check foreign transaction fees before using a card abroad. Some charge nothing; others add several per cent to every purchase.
• This is general information rather than advice. Terms vary considerably between cards and countries — read your own agreement.

Common mistakes

• Paying only the minimum — Interest then applies to the full balance from the purchase date on most cards, and clearing it can take decades.
• Withdrawing cash on a credit card — It typically carries a fee plus interest from day one with no interest-free period. It is among the most expensive borrowing available.
• Forgetting when a 0% period ends — The standard rate applies to the remaining balance from that date, which can be a substantial jump.

Questions people ask