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Beginner's guide to credit cards

Whether you're a first-time borrower or just confused about some aspects of credit cards read our guide to the ins, outs, ups and downs of the whole system before taking the plunge and comparing deals.

For more information on the types of deals suitable for first-time users, take a look at this article here.

Credit cards in two sentences

Credit cards allow consumers to spend money flexibly, allowing cardholders to: manage cash flow; borrow cheaply in the short term; earn rewards and/or enjoy more protection on purchases.

However, all credit card use is a form of borrowing and transactions will accrue interest over time as well as fees if the cardholder doesn't stick to the provider's rules of repayment.

Credit card glossary

The tension in those two sentences - the benefits of holding a card tempered with a warning - is one you'll find throughout articles on using and looking for credit cards and, indeed, in literature from the providers themselves.

That makes understanding the terms providers and information sites use when they talk about credit cards pretty vital, we think.

With that in mind, here's a beginner's glossary.

APR

Credit card providers must advertise the Annual Percentage Rate (APR) alongside all deals by law.

The APR is made up of the rate of interest that cardholders will pay on any outstanding balance which makes up the credit card's main intended use as well as any mandatory fees applicable to all cardholders.

The main intended use is, in the vast majority of cases, the annual rate of interest cardholders will pay on purchases they've made on the card.

This is true even of 0% balance transfer credit cards even though cardholders can often face an interest rate on transferred balances much higher than the (advertised) purchases rate once the 0% introductory period has come to an end.

Under the Consumer Credit Directive 2011, the advertised interest rate must be available to at least 51% of those that apply for a credit card.

The other 49% of applicants may be offered a higher interest rate. Providers base that decision on risk which they assess through an analysis of applicant's credit history.

It's worth knowing as well that, once an interest rate has been offered, under the same Consumer Credit Directive, cardholders now have the right to reject interest rate rises and while they may have to close the account, they can then pay back any debt owed at the original rate.

Allocation of payments

The allocation of payments, or order of payments, clause governs the way that credit card providers pay off a card debt.

It means that the balance on the credit card is broken down into a selection of sub-balances: purchases, for example, will be separate from cash withdrawals.

Providers then follow this order so that the highest rate balances are paid off first, minimising the amount of interest paid.

The clause can run into trouble when cardholders use two 0% offers at the same time, however. See our guide on this subject for more information.

Balance transfers

A balance transfer is an offer which credit card providers use to attract new customers who already have credit card debts elsewhere.

The providers offer their new customers the opportunity to move an old credit card debt to the new card in return for a limited time 0% rate or life-of-balance (unlimited time) low rate.

By making that balance transfer cardholders can potentially pay off debts much more cheaply, although there is usually a fee to pay for the benefit as well as other long-term risks.

Find (more information here) on using and comparing credit card balance transfers.

Cash advance transactions

Credit card providers count cash withdrawals (from an ATM or at the till), gambling purchases (including buying food at a casino) and foreign currency purchases, as well as some other transactions as 'cash advances'.

They're worth knowing about, there's a whole guide here, because they'll often incur higher rates of interest, as well as handling fees, both of which will often be charged from the day cardholders make the withdrawal - even if the statement balance is repaid in full.

Default charges

If cardholders roll a balance over between statements (i.e. don't pay it back in full) they will be charged interest.

If the smallest amount required to be paid back is not paid at all, then cardholders will be charged a default fee, capped at £12.

Even when credit cards have 0% interest cardholders still have to make minimum repayments.

Missed payments will appear on credit reports and could lead to special offers - such as a limited 0% rate - being withdrawn altogether.

Default charges are also applicable when cardholders make purchases on their card in excess of their credit limit.

Credit limit

Providers offer a credit limit for transactions which caps the amount cardholders can borrow.

The limit is risk-based - those with better credit histories will have a higher limit - although it also varies by card so is sometimes worth taking into account in a credit card comparison.

Direct debits

Credit card providers are now pretty good at asking their customers to set up a direct debit: a monthly payment from a current or savings account to cover the minimum payment.

However, direct debits are a double-edged sword: they prevent default charges but, on the other hand, they can encourage cardholders to just make the minimum payment, one of the most expensive ways to borrow.

Interest free period

Credit card purchases are subject to a standard interest free period (usually around 56 days) when the balance is paid off in full.

Cash advance transactions, fees and balance transfers are usually not included in that standard interest free period.

Minimum monthly repayment

As mentioned above, if the smallest amount required by the provider isn't paid back of an owed balance each month the account is in default: charges are added and the missed payment is recorded on a credit report.

That smallest amount is called the minimum monthly repayment.

It's now, by law, at least 1% of the balance owing plus any interest and charges added to the account that month, though it can be higher and has a minimum of it's own - an amount that when reached triggers the full balance to be repaid, often around £25.

See our full guide to minimum payments for more information and the best deals.

Paying off in full

Paying off in full means transferring the whole amount owed on the card statement to the provider.

This term is frequently used to emphasise that if cardholders pay this whole amount at the end of the statement period they can avoid interest subject to interest-free periods as above.

When cardholders pay less than the entire amount owed they will be charged interest on the whole amount for the past month and the remaining amount going forward.

To make that clear let's use an example. Say a credit card has a £100 balance, the cardholder made the £100 purchase 10 days ago so if they pay off in full - that's £100 - they'll pay £0, nothing, in interest.

If, instead, they pay off £99 they'll be charged interest on £100 for ten days and on £1 until the next payment is made.

Standard interest free periods vary very little so consumers rarely use them to compare credit cards.

Purchase protection

Make many purchases on a credit card and they'll be better protected than they would be if they were made on a debit card or in cash.

That's because credit cardholders are covered by section 75 of the Consumer Credit Act 1974 which makes card providers equally liable, with retailers, for ensuring that goods and services are actually delivered.

The law is complex - you can learn more about it in this full guide - but it is also an extremely useful addition to any credit cardholder's vocabulary.

Note that, although some providers offer limited additional protection, this law will cover all eligible card payments so it should rarely be a factor when consumers compare credit cards.

Quick start: credit cards offers

As you can see, credit cards are some of the most complex financial tools consumers have at their disposal.

As a result many credit card users find it useful to search for and then use their cards as 'tools', for one particular use.

For example, as this guide notes, a 0% purchase credit card could be used for spreading the cost of a period of high spending over a number of months.

Some cardholders have more than one credit card to ensure each one is providing a certain feature as credit cards are often poor performers when it comes to multitasking.

It can often be useful then to have a main type of use or purpose in mind when using a credit card comparison or information site.