Few things are more confusing to people than the two areas of finances and law. When you bring those two areas together, like with credit cards for example, the waters become even more muddied. Despite the fact that so many UK adults use credit cards, very few are thoroughly versed in the finer details of how they work and how they should be used.
Understanding the vocabulary of the credit card industry goes a long way in helping to understand how it all works. After all, words mean things. This guide is intended to teach you the credit card and finance terms you need to know in order to understand your own financial position. The more you understand, the better you will be at protecting your own finances.
Credit Card Basics
The best way to get started here is to define what a credit card actually is. A credit card is a piece of plastic representing a cash loan your issuer is prepared to give you so that you can purchase something you need. Just like a paper cheque is a representation of money your bank is holding on your behalf, a credit card represents money the bank is willing to loan you.
A credit card is also a representation of something called "unsecured credit." It is considered "unsecured" because there is no collateral, or property, you are putting up as a promise to repay the loan. The opposite side of the coin is what is known as "secured credit." This is credit in which your property acts as security for the loan. A good example would be your mortgage. Your house is security inasmuch as the bank can repossess and sell it should you not pay your loan.
Remember that credit cards are not free money on an unlimited basis. Every time you charge something to your credit card, you are taking another loan from the bank, a loan that comes with interest and other fees as applicable. It costs you extra money to use a credit card over cash.
Interest and Interest Rates
When you borrow money through any financial vehicle, you are charged interest. Interest is the extra money you pay above and beyond what you borrowed for the privilege of being able to borrow it. Interest is how lenders make a profit. The higher the interest rate, the more you pay and the more profit your lender earns.
Here are some of the interest related terms you need to know along with explanations:
- Annual Percentage Rate (APR) - Interest is calculated as a percentage of how much you still owe on your loan. Where credit cards are concerned, it has calculated based on your outstanding balance. The annual percentage rate is the total rate of interest you will pay over a 12-month period.
- Variable Rate - A variable interest rate is one that fluctuates according to current financial conditions. Some variable rates move up and down by the day while others are adjusted monthly.
- Fixed Rate - A fixed interest rate is one that remains constant regardless of the market conditions. Fixed rates on credit cards are the norm, though they do tend to be reassessed on an annual basis.
- Penalty Rate - This interest rate is a punitive rate assessed to your balance should you miss a payment. In most cases, the penalty rate will be reduced back to the normal rate after six months of consecutive, on-time payments. The penalty rate may also be imposed for other infractions of the credit card agreement.
- London Interbank Offered Rate (LIBOR) - This is the interest rate banks pay for borrowing money themselves. Credit card interest starts with the LIBOR rate and goes up from there.
Monthly Statements and Payments
Once every month credit card users receive a statement from the credit card company detailing all of the activity on the account. The statement will list any payments made, any charges to the card, and any fees assessed. There will also be a due date by which time payment must be made.
Learning how to read and decipher a credit card statement is a necessary skill if credit card holders hope to keep their finances under control. Here are some of the terms you should be familiar with:
- Billing Cycle - The billing cycle is a set number of days used by the credit card company to calculate interest and other fees. A typical billing cycle is 30 days; it could start on any day of a given month. Billing cycle is important when determining how interest rates are charged.
- Average Daily Balance - This is the average amount of money you owe to the credit card company for every day of the billing cycle. It is calculated by adding up the actual balance for every day of the cycle then dividing it by the number of days in the cycle. Some credit cards charge interest based on the average daily balance; others charge interest only on the balance at the end of the cycle.
- Balance Transfer - Balance transfers occur when you pay off one credit card by using another. In simplest terms, your second credit card company agrees to assume the debt of the first card in order to allow you to pay the first card off. When you perform a balance transfer you are not free of the debt, you are just switching it to the new credit card company.
- Grace Period - The grace period is an extra few days after your due date whereupon you can still make payment without incurring penalties. Grace periods are seldom longer than five business days.
- Credit Limit - This is the total amount of money you can borrow for purchases and balance transfers. If your limit is £10,000 and your balance is £5,000, you can still charge an additional £5,000 to the card.
If you use a credit card like it were cash -- i.e. you never use it to purchase anything you do not have the cash to cover -- you can pay your balance in full at the end of the cycle and never incur any interest charges. Although this is always the best way to use a credit card, it is not always possible to do.
Credit Card Rewards
Credit card companies are always looking for new ways to attract business and keep existing customers. One of the ways they do so is through rewards programs that offer incentives designed to encourage customers to use their cards. There are many different rewards programs from which to choose.
The thing to be careful about where rewards are concerned comes by way of their value. For example, a card offering you free airline tickets may be very attractive if you fly a lot. However, if you have to spend £50,000 just earn a £3000 ticket it might not be worth it to you.
Here are some of the different types of reward programs available:
Point Rewards - The point reward system is the most common for today's credit cards. Users accumulate points for every purchase they make in participating categories. When the user has accumulated a certain amount of points they can be redeemed for merchandise, travel, VIP events, and so on.
- Travel Rewards - A card offering travel rewards provides all sorts of discounts and free services to cardholders. We have already mentioned free airline tickets, but travel rewards can also come by way of rental car miles, hotel discounts, tour package discounts, and free travel merchandise.
- Cash Back Rewards - Cards offering cash back rewards typically reimburse cardholders between 2% and 5% of their total purchases. If you are able to pay your bill every month in full, a cash back card ends up actually paying you to use it. It is a great way to use a credit card to your advantage.
Different Types of Credit Cards
When you apply for a credit card, the lender checks your credit history and other factors to determine what you qualify for. This is necessary because there are several different types of credit cards appropriate for various circumstances. If you apply for a card requiring a stellar credit history and you do not qualify, that does not mean you can get one of the other types of cards. It is just a matter of applying until you are able to get one.
Here are some of the most commonly used types of credit cards:
- Basic Card - The basic card is the starter card for people with fair to good credit. It typically offers an affordable interest rate and a decent credit limit. Usually there are no rewards attached to the basic card.
- Standard Card - A standard card is one for those with good to excellent credit. It tends to have a slightly lower interest rate than the basic card, plus the addition of some incentives like travel insurance, concierge service, and maybe a reward or two.
- Platinum Card - A platinum card is the most attractive because it offers rewards and incentives. Unfortunately, platinum cards are reserved for only those with excellent credit histories. When you qualify for a platinum card, you qualify for the lowest interest rates, the best rewards, and VIP treatment.
- Rewards Card - As previously discussed, this is a credit card with rewards attached to encourage you to use it. The more you use the card for the greater your rewards are.
- Security Credit Card - The secured credit card is great for people trying to rebuild poor credit or those with no credit at all. Here's how it works: you deposit cash with the credit card company, which is used as collateral against your balance. Whatever amount you deposit is the limit of your credit. As long as you pay your monthly bills on time, the lender never touches the money deposited. If you miss a payment, or default completely, the lender will take what you owe out of that deposit.
- Prepaid Credit Card - The prepaid credit card is actually not a credit card of all. We have included it here only because the terminology is pretty prevalent. A prepaid credit card is nothing more than a debit card issued by a credit card company. You load it with cash and then use it for purchases until the balance runs out.
- Merchant Card - The last kind of card is the merchant card. This credit card is specific only to the merchant who issues it; it cannot be used anywhere else. For example, if you got a merchant card from your local department store, it could only be used for purchases made at that company's retail locations. You could not use it to purchase petrol or airline tickets.
Credit cards are great tools for those who know how to manage their finances. They are convenient to take care of emergencies, to replace the need for carrying cash in your pocket, and to earn some rewards along the way. Now that you know most of the terminology, you should be better prepared to apply for a credit card best suited to your needs.
Just be sure to treat credit cards very seriously. If you are undisciplined in your spending, they can easily become a trap that overwhelms you and destroys your personal finances. Used responsibly on the other hand, they open up lots of great financial opportunities you may not have had otherwise.
Credit cards in the UK are typically branded by one of a small handful of major card companies. The branding tells the merchant the card is backed up by a financial institution that will pay the bill even if the borrower and the issuer both default. Here are links to three of major branding companies:
Visa - This is the UK site of the global credit card company. It provides links to all sorts of information including current cards, special promotions, financial management, and business opportunities.
MasterCard - The main page for MasterCard in the UK. From here, you can click on links to learn about MasterCard products, find a MasterCard charge card that works for you, and keep abreast of current promotions and special offers.
American Express UK - American Express is a little bit different in terms of how their cards are issued and used. On this site, you can learn all about them and where to find one in the UK.
When you search for credit cards using a comparison website, you are able to get all of the necessary information in one place. It makes shopping a lot more efficient and fast. Here are links to some of the UK's most well-known comparison sites where you can find and apply for credit card offers:
Go Compare - Offers credit card comparisons from most of the UK's biggest issuers. Here you can find offers for basic cards, rewards cards, cash back cards, and more.
Money Supermarket - This site claims you could save up to £200 when you apply through them. They offer side-by-side comparisons among some of the big names plus a search tool that lets you find credit card offers from all across the industry.
Confused.com - Another site offering comparisons from across the entire UK market. You can compare cards according to interest rates, card type, or rewards programs.
Compare the Market - Dozens of credit card offers are compared here. They are ordered under different categories according to card type, making it easy for you to find the specific type of card you are looking for.
Tesco Compare - Offering credit card comparisons through its online partner, Love Money. They also offer helpful information about how credit cards work and things of which you should be aware.
uSwitch.com - On this site you will find comparisons among dozens of different cards laid out in an easy-to-read grid format. At a glance, you can see representative APRs, introductory interest rates, and rates on balance transfers.
Money.co.uk - Compare more than 260 credit card offers on this site. They also use a grid format to give you information about balance transfers, purchase rates, and representative APRs.
Totally Money - Offering what this site refers to as a "revolutionary" tool to search for credit cards and protect your credit. The tool allows you to customise your search so that you are not wasting time with credit cards for which you will not qualify.
Money Saving Expert - If you ever needed more information about credit cards this is the site to visit. They have a number of very helpful guides that will explain the ins and outs of the credit card industry in language you can understand.