Credit cards are one of the most commonly used financial products in Australia (there are around 17 million of them in circulation). They are also one of the most commonly misused and misunderstood products.
Here we answer 20 questions to help you understand exactly what credit cards are, how they work when you’re applying, using them, paying them off, and everything in between.
What is a credit card?
A credit card is a payment card that lets you make purchases and complete other transactions using money you borrow from the card issuer. This is usually a bank, but not always.
You essentially have access to a line of credit up to a limit for spending using your credit card. You can spend that money at stores and other physical points of sale (restaurants, coffee shops etc.), as well as online. You can also use your credit card to pay bills through direct debit or using BPAY.
You need to pay back any money you spend using your credit card and you may be charged interest if you don’t repay the full amount due every time you get a credit card bill.
To understand how a credit card works, it helps to think about the steps involved when applying for a credit card, then using it and paying it off:
How do credit cards work?
1
You apply for your credit card of choice with a bank or other provider.
2
Your application is assessed based on your financial situation and credit history.
3
If approved, you’ll be issued with a card with a maximum credit limit.
4
You get a physical card, which you can also add to your phone to ‘tap and pay’.
5
Some cards allow you to earn ‘rewards’ points based on your spending.
6
Every month you get a credit card statement showing your transactions and what's owed.
7
To avoid interest being charged, you need to repay the full amount when it's due.
8
With the balance paid, your full credit limit is restored and the statement cycle starts again.
What's the difference between a credit card and a debit card?
Brad Kelly, Credit Cards Expert
With a debit card, you're spending your own money from your bank account. With a credit card, you're spending the bank's money then paying it back. Another difference is cost. Debit cards are free to use in most instances, but your bank will charge you to use a credit card, if you let them.
Brad Kelly, Credit Cards Expert
Why would you get a credit card?
Here are some of the reasons people get a credit card. It can also be a mixture of reasons.
- To make purchases and pay them off later.
- To have access to money in an emergency.
- To earn rewards or frequent flyer points that can be used to buy things (e.g. flights or other benefits through Qantas credit cards).
- To access other perks that credit cards offer, like insurance that covers the items you buy, travel insurance and extras like passes that give you access to airport lounges.
What types of credit cards are there?
Low fee credit card
Comes with a low or no annual credit card fee.
Low rate credit cards
Charges a relatively low rate of credit card interest.
Rewards credit cards
Offers the ability to earn rewards points and offers other benefits. High fees and rates usually apply to rewards credit cards. There are also cashback credit cards that earn you money which is credited to your card account instead of points.
Frequent flyer credit cards
Frequent flyer credit cards offers points and benefits connected to an airline loyalty scheme. They also often come with travel related perks like airport lounge passes for the cardholder.
Balance transfer credit cards
Balance transfer credit cards allow you to switch the balance of a credit card you already have to the new card.
Business credit cards
Business credit cards are available to companies for covering businesses expenses. There are also corporate credit cards designed for companies with a large turnover who require lots of cards for employees.
Charge cards
Charge cards are very similar to credit cards, but there is no set credit limit and the cardholder must pay off the full balance each month. There are no interest charges on charge cards.
Virtual credit cards
Virtual credit cards are digital versions of physical credit cards offered by some lenders. These cards provide convenience by being accessible on smartphones through apps and digital wallets. Virtual credit cards also offer enhanced security features, generating unique card numbers for each purchase, reducing the risk of fraud and unauthorised use.
How much does a credit card cost?
The cost of your credit card will depend on the type of card you choose, which credit card provider you get it from, and how you use it. Here are the main costs:
- Interest
- Annual credit card fee (some cards have a monthly fee instead of an annual one)
- Cash advance fees
- Late payment fees
- International credit card transaction fees (if you make purchases overseas but some cards waive the FX fees)
Brad Kelly, Credit Cards Expert
"Paying an annual fee is not necessarily a bad thing if it means you’re getting a lower interest rate. You might be planning to never have a balance being charged interest on your card, but if you ever do have a balance the interest rate will matter, a lot."
Brad Kelly, Credit Cards Expert
How does interest work on a credit card?
Credit card users can be charged interest by their provider depending on how they use their card.
Credit card interest rates are variable, meaning the provider can change your interest rate at any time, although they tend to not change very often. The rate is expressed as an annual percentage rate – e.g. 21.99% p.a. (per annum).
Different interest rates that can apply
Purchase rate
This applies to money you use to pay for products and services, either in-store or online. Interest is only charged on purchases if you have not paid off your credit card in full by the due date shown on your statement.
Cash advance rate
You pay the cash advance rate on any money you withdraw at an ATM or if you transfer money from your credit card to another bank account. The cash advance rate is usually higher than the purchase rate.
Balance transfer rate
This is the rate applied to any amount you switch to your credit card from a different card. This is usually a lower rate but it reverts to a higher rate after an introductory period.
What are the pros and cons of a credit card?
Pros
- Offers ongoing access to credit if you need it
- Can be useful for accessing money in an emergency
- Most come with extra benefits and perks
Cons
- There is usually an annual fee to pay
- The interest rates are usually quite high (e.g. compared to a personal loan)
- They can encourage people to overspend and build up debt
