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Published October 23, 2023
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7 minutes

How Do Credit Cards Work?

Everything you need to know about how credit cards work and how to use them responsibly.

Credit cards are a popular payment method used around the world. There are various types of credit cards available, such as rewards cards, low interest cards and cards with premium perks. 

But while credit cards have their benefits, they can also lead to debt. In July of 2023, there were roughly $12.6 million personal credit card accounts in Australia, according to data from the Reserve Bank of Australia. And, on average, there was approximately $1,110 of debt per card accumulating interest.

Credit card debt can spiral out of control, so it’s important to understand how credit cards work before you start swiping.

What is a credit card?

Many Aussies have at least two cards in their wallets: a debit card and a credit card. 

Debit cards are linked to your bank account. When you use a debit card, it takes money directly from your account. 

A credit card, on the other hand, is a revolving line of credit issued by a bank or financial institution. When you use a credit card, you’re using the issuer’s money, which you then have to pay back or be charged interest on the balance. 

Credit limit

The credit limit is the amount you are allowed to charge to the card, and is set by the issuer. Issuers use your credit history, among other factors, to determine the card’s credit limit. 

When you use the card, the available credit decreases. When you pay off the amount you borrowed, the available credit goes back up. For example, if your card has a credit limit of $5,000, you can charge up to $5,000 to the card. If you spend $4,000, you’ll only have $1,000 of credit available. If you pay off the balance, you’ll have the full $4,000 available again. 

Transactions can stay on your account as ‘pending’ for a few days, and may not be reflected in your available credit. Your balance may appear to be -$1,000, for example, but a pending $250 charge means the real balance is $-1,250.

Double-check your statement before you use the card so you know exactly how much credit you have available. Going over your credit limit can lead to declined transactions, and you may be charged an overlimit fee. 

Credit card interest rates

At the end of each billing cycle, you must pay off the balance to avoid being charged interest. Credit card interest rates — often referred to as APR — can be high (around 20%), so you want to settle the bill in full, if possible. 

Minimum payments

Minimum payments are the lowest amount you can pay back to keep the account in good standing. It’s typically a percentage of the balance, such as 2%. Failure to pay at least the minimum payment can result in fees and penalties.  

If you can, always pay more than the minimum payment so you can clear the debt faster.

When to get a credit card

Before you get a credit card, consider what you’ll be using it for and why. For example, you may want a card to help you build your credit — using the card responsibly over time can show lenders that you’re a trustworthy borrower.

Alternatively, you may want to take advantage of the rewards that some cards offer, such as travel points. Weigh up the cost of the card and the value of the rewards before you apply — if you don’t use the card regularly, you may not earn enough points to make the annual fee worth it.  

Another popular reason to get a credit card is for emergency purchases. If an unavoidable bill falls on your lap, a credit card can help you pay it quickly. However, while you may avoid late fees on the bill, you’ll incur interest on the credit card if you don’t pay off the balance. 

Getting your first credit card? Whether you’re a beginner or a credit card pro, make sure you know how to handle a credit card responsibly. It’ll save you time, money and frustration.

How do different types of credit cards work?

There are various types of credit cards available, each with unique pros and cons. 

Here are a few of the popular types: 

Low interest cards: A great option for consumers new to credit, these cards charge a low, ongoing interest rate and typically have low fees. 

Premium cards: If you want high-end perks and extensive insurance extras, you may want to consider a premium card. However, these cards typically come with a hefty annual fee. 

Frequent flyer cards: Earn thousands of frequent flyer and reward points simply by signing up for certain credit cards. You can then use those points to pay for flights, hotels and more. 

0% interest cards: Balance transfer cards usually come with a 0% interest introductory offer for a set period of time, then move to a standard rate. These cards can help move your debt to a card without interest to help you get ahead with repayments. 

No annual fee cards: Some credit cards do not charge an annual fee, but the perks and benefits may not be as extensive as the ones that do. 

Business cards: Many issuers offer cards specially designed for businesses. You can use a business card to track business-only outgoings, and provide cards for employees.  

Reward program cards: Rewards cards allow you to earn points with every dollar you spend. Once you’ve earned enough points, you can redeem them for products and services. 

Store cards:  These cards are offered by brands and large retailers, and can come with higher interest rates than standard credit cards. Some store cards can only be used in the parent store, while some can be used outside of the store for everyday spending. 

Credit card fees and features

Using a credit card responsibly is about more than paying it off in time, every month. Understanding what credit card fees may apply can help you avoid unnecessary penalties. Keep these fees and features in mind when shopping for a credit card. 

  • Annual interest rate (APR) on purchases, sometimes referred to as the purchase interest rate.
  • Cash advance interest rate and fees. A cash advance is when you withdraw money using the credit card, such as at an ATM. Gambling purchases and travellers cheques are also considered cash advances. 
  • Interest-free window when you sign up for a card, such as 0% interest on balance transfers for three months.l  
  • Annual credit card fee. Depending on the type of card and the perks it offers, annual fees can range from $0 to upwards of $1,000.  
  • Rewards program fee. In some cases, you may be charged a fee for access to the card’s reward program.  
  • Late fees may be applied to your account if you miss a payment. Setting up an autopay can help you pay at least the minimum amount due on time 
  • Charges for exceeding your credit limit, if applicable. Some issuers only apply this charge if you opened the account prior to a certain year. 
  • International, or foreign exchange, fees may be applied if you use the card abroad. 

🤓 Nerdy Tip

As of August 2023, the average interest rate for a standard personal credit card was 19.85%, according to data from the Reserve Bank of Australia. When shopping for a card, check if the annual interest rate on your card is similar to the industry standard. If it’s higher, you can ask the issuer for more information on why. If you always carry a balance from month to month, make sure you choose a card with a low interest rate.  

As with every financial decision, choosing a credit card comes down to your specific needs and situation. Be sure to ask the issuer detailed questions about fees, perks and interest rates before applying for a credit card

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