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How do credit cards work?

Everything you need to know before getting your first credit card

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Credit cards give people a convenient way to make payments for a huge range of goods and services. It allows you to pay for the things you want to buy, but don’t have the money to pay for now. People often use credit cards to pay for weddings, holidays and so much more. But it’s essential to understand the features and charges that come with a card before deciding which one is right for you.

In the era of contactless payments, consumers are increasingly using credit cards to pay for goods and services. In fact, according to one source, as at November 2020, there were 13,668,490 credit cards in the Australian market.

Taking out a credit card and using it to make payments means you don’t have to carry large amounts of cash. But it’s important to understand the interest and fees charged by credit card providers on the balance that you will need to pay off each month.

When you take out a card you will be given a limit. This is the amount you can spend, based on the credit card provider’s assessment of your creditworthiness and the limit with which you are comfortable.

Most lenders allow consumers to apply online for a credit card. When you make your application, you will need to provide identification documents, proof of your existing assets and liabilities and proof of your salary or wages. Lenders use this information when determining whether to offer a consumer a card, the card’s limit and the interest rate. They also check the borrower’s credit score so they can understand their history repaying debts. You can check your credit score for free right now at ClearScore.

There is a number of different card types and the right card will depend on your circumstances.

Zero interest

This card does not accrue interest for a period of up to 12 months, after which point interest is charged on the card’s balance. People often use this type of card when they consolidating their credit card debts into one card, with a view to paying off as much of the card’s balance as possible during the interest-free period.

Check when the interest-free period ends and also the rate that will apply to all future transactions. This is because after the interest-free period finishes, some lenders charge a rate that’s above the market average to recoup the interest waived during the interest-free period. So check what the rate will shift to after the end of the interest-free period.

Low fee or low rate cards

Low fee cards tend to have a higher interest rate than the market average and are often used by people who intend to pay off the card’s balance in full before the end of the interest-free period. In contrast, low rate cards often suit people who don’t pay off the balance in full each month, to help them to reduce the interest they pay. They typically have a higher annual fee to make up for the lower rate charged. Check the fees and charges before you take out a card.

Awards points

Many cards come with an associated rewards program, through which consumers earn points for using the card to make purchases. For instance, many cards issued by airlines have an associated rewards program. Cardholders are rewarded when they use the card to buy airline or a range of other goods. Points accrued can go towards the price of future airline tickets. Rewards points can also be redeemed to buy products and services from businesses affiliated with the program.

Premium cards

Borrowers can apply for a premium account if they spend above a certain amount each year. These cards charge higher fees and interest rates and come with a substantial credit limit. Cardholders can access a range of benefits through cards such as access to airline lounges, discounts and travel insurance.

You will need to pay off a certain amount each month. Your credit card statement includes information about the minimum payment you need to make each month. Paying late or not paying can negatively affect your credit score with this information stored on your credit report. This is information compiled by credit bureaux, including your payment history, defaults and the amount of debt you already have. It gives lenders a good understanding of the borrower’s history paying off debts. However, it’s a good idea to only apply for one card at a time. This is because making multiple, consecutive applications can negatively affect your credit score.

Credit cards are a very useful way of making payments. If you are considering taking out a credit card, it’s recommended to review different options available to you, given your individual circumstances. Compare fees, charges, interest rates and any special features the card offers when deciding which one to take out. Importantly, make sure you are comfortable meeting the repayments and responsibly making repayments when you do take out a card.

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