How do credit cards work?

What Is a Credit Card and How Do They Work?

David Hickman
David is the editor for the money section of UK based comparison website PocketRate.com.

A credit card is simply a physical piece of plastic that is used as a replacement for using actual bank notes or coins in order to pay for goods or services.

Each credit card will have a credit limit that restricts you spending above a certain amount on the card. The money you spend on your credit card will need to be paid back at the end of the month or over a period of time.

What is the difference between a credit card and a debit card?

With a credit card, you spend money using your line of credit from the provider. This money is then paid back in full or in regular repayments. Using a credit card to pay for things may incur charges such as interest and other fees.

A debit card on the other hand is linked directly to your bank account. When you pay for things using a debit card, the money is automatically taken out of your bank account.

Credit Limit

The amount of your credit limit is determined by the provider and is based on a number of factors including your income and past credit history.

Your credit history will be checked during the application process. This history can include details of money you have previously borrowed together with a record of how well you repaid the money back. Your credit file may also include any current credit arrangements you have such as existing credit cards, loans, mobile phone contracts and mortgage information.

This information produces your credit score or credit rating. Essentially, this rating will determine how suitable you are for the credit card and how much your credit limit should be.

You should consider checking your credit score and credit report before applying for a credit card.

Types of credit card

Some credit cards offer various introductory rates, rewards or are focused on helping you build a credit history

  • Balance Transfer Credit Cards

    These cards allow you to transfer the debt from an existing card to a new card with a different provider in order to take advantage of lower interest repayments. Balance Transfer credit cards can offer 0% interest on the amount transferred usually for a set period of months.
  • Purchase Offer Credit Cards

    These cards can offer 0% interest on new purchases for a set period of time. Purchase credit cards are generally used to buy large, more expensive items in order to take advantage of repaying back the amount without interest. However, after the 0% interest period ends, the rate will generally revert back to the standard interest rate on the card. Therefore, you should plan to pay back the amount before this happens.
  • Rewards Credit Cards

    The rewards offered by these cards can be in the form of vouchers, discounts and money off your bill. Some rewards credit cards offer reward points such as Nectar Points that can be redeemed for money back on your shopping. Certain cards are designed for frequent travellers and offer Air Miles that you can accumulate and buy airline tickets with.
  • Cashback Credit Cards

    These cards pay you cash each time you spend money using the credit card. Some cashback credit cards offer introductory rates that give you a higher percentage of cash back during a set period of time.
  • Credit Builder Credit Cards

    If you have a poor credit history or very little or no credit history, then a credit builder credit card may be worth looking into. Essentially, these types of cards offer a very limited amount of credit and are designed to help you build up a good credit history for the future. They usually have more relaxed application requirements. However, they often have higher interest rates than other cards so you should aim to repay the full amount at the end of every month in order to avoid steep interest repayments.

How to compare credit cards

  1. The first thing to do is to decide your reasons for having a credit card. Are you looking for rewards points, transfer an existing balance, make a large item purchase or build up your credit history?
  2. Narrow down your search for a card type that best suits those requirements. See the explanation above as to the type of cards available.
  3. Once you have a list of cards that meet your needs, focus on the specific rates charged, other potential fees, rewards and introductory offers.
  4. Consider checking your current credit score and credit report before applying for a credit card. Ensure your finances are in a healthy state and your credit history is sufficient to meet the requirements of the card.
  5. Apply for a credit card online using the links provided in the PocketRate Credit Card Table.

You can use the PocketRate website for free to compare credit cards and find a card that is suitable for you.