How do credit cards work?
A beginner's guide that explains how credit cards work, what they cost and how to choose the right one for you.
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Credit cards give you a way to buy what you want now and pay it off later, over time. You get a set amount you can spend, known as your credit limit, and receive statements each month. Usually, you'll pay interest when you carry a balance on your card. But there are also ways to avoid interest, including interest-free days, 0% interest rate offers and cards that charge a monthly fee but no interest. Other common credit card features you need to know about include annual fees, rewards and complimentary extras.
Here, we explain the key features and standard costs of a credit card so you can find the right one for your budget. You can also find out what types of credit cards are suited to beginners and the mistakes you should avoid to get your credit card history off to a good start.
How does a credit card work?
A credit card works as an unsecured revolving line of credit. "Unsecured" because there is no asset as collateral (such as a car or home) and "revolving" because you can use the card on an ongoing basis (unlike, say, a personal loan that you use and pay off over a set term). So you can use the card for your spending, then get a monthly statement that tells you the total amount you owe for that billing period. You then have the choice of paying some or all of the amount off, with a minimum required payment that's usually around 2-3% of what you owe.
The maximum amount you can spend with your credit card is known as your credit limit. This is assigned by the credit card provider based on your perceived ability to make repayments (although you can include a credit limit request when you apply). Unlike a debit card that lets you spend your own money, you are borrowing the bank's money when you use a credit card and if you don't pay it back on time you are charged interest.
How credit card interest works
When you pay with a credit card, your spending will attract interest charges unless it is eligible for an interest-free period (or you have a no interest monthly fee card). When interest does apply, there could be different rates depending on the type of transaction. For example, the interest rate for purchases typically ranges from 8.99% p.a. to 21.99% p.a., while for cash advances it is often around 18.99% p.a. to 21.99% p.a.
Credit card interest is calculated based on your account's daily outstanding balance, then charged monthly at the end of the statement period. This means you could save on interest charges by making more than one payment per month. You can check out Finder's credit card repayment calculator to learn more about this.
What are the features of a credit card?
- Credit limit. This is the maximum amount of money you can borrow using your credit card. While you can request a specific credit limit at the time of application, your credit card will be determined by the bank based on your income and credit history. Note that minimum credit limits do apply and can range between $500 and $15,000 depending on the card. While you don't have to spend all your credit limit, you'll want to make sure that the minimum credit limit doesn't exceed the maximum you had in mind.
- Interest-free days. Most credit cards give you a way to make interest-free purchases by offering up to 44 or 55 days interest-free. The interest-free period begins on the first day of your statement period, and run through to the due date for a payment at the end of that statement period. Interest-free days usually only apply if you've paid your entire balance in full.
- Balance transfers. If you're struggling to pay off an existing debt, you can transfer the balance to a credit card with a different provider and get an introductory low or 0% interest rate on the balance transfer for an introductory period. This will give you time to pay down your debt while paying low or no interest rate on the balance. If you still have debt from the balance transfer at the end of the introductory period, a higher rate of interest will apply.
- Cash advances. Using your credit card to withdraw cash from an ATM, make gambling purchases, buy foreign currency or pay some bills will be considered as cash advance transactions. Cash advances attract a cash advance fee, are not eligible for interest-free days and usually attract a higher cash advance interest rate.
- Rewards programs. A rewards credit card gives you a way to get rewards when you pay by card. Usually, you'll earn points through a rewards or frequent flyer program and can then redeem them for travel, gift cards, retail items or cash back. A few other cards offer cashback rewards instead of points. Many rewards cards also offer thousands of bonus points when you meet a spend requirement after signing up. However, these cards often come with higher annual fees and purchase rates.
- Contactless and mobile payments. For purchases under $100, you can tap to pay with your credit card at the checkout without needing to enter a PIN. A lot of cards also offer contactless mobile payments when you add them to Apple Pay, Google Pay, Samsung Pay and other mobile wallets.
- Insurance covers. Lots of credit cards offer some form of complimentary insurance. This can range from purchase protection insurance and extended warranty cover to overseas medical travel insurance and transit accident insurance. Usually, the more premium cards offer more comprehensive cover, but it's always worth checking the insurance information booklet for full details.
- Extra features. Some credit cards come with extras such airport lounge access, concierge services, invitations to exclusive events, discounts with partnered retailers and much more.
What are the costs of a credit card?
- Repayments. Although you're required to make the minimum repayment when your statement is issued, you're free to repay as much as you like and as often as you like beyond this minimum. The minimum repayment is usually only 2% or 3% of your outstanding balance, so it's best to pay your account in full (or as much as you can) each statement period to reduce your interest costs. You will pay a late payment fee if you don't make the minimum repayment by the statement due date.
- Annual fee. This is the cost of the credit card account. Annual fees range from $0 to $500 or more depending on the type of credit card. The credit card annual fee is deducted from your available credit limit and accrues interest at the purchase rate if it isn't paid in the first statement period.
- Interest rates. Interest is the price you pay to borrow money. Credit card interest rates are much higher than other types of finance because credit cards are an unsecured product. This means financial institutions cannot take your assets if you default on your repayments. You can avoid interest charges if you get a no interest monthly fee credit card or take advantage of interest-free days. You could also save on interest with a card that offers 0% p.a. for an introductory period.
- Other fees. Other fees you may run into include late payment fees, overlimit fees (a fee for spending past your credit limit), rewards program membership fees and cash advance fees.
What are pending and pre-authorised transactions?
A pending transaction is any transaction that is still being processed. For example, you could buy something right now and see it listed on your account as "pending". Then, once the merchant and payment processors have finalised the payment, it will show up as a transaction.
A pre-authorisation is a temporary transaction where a set amount of funds from your credit card or debit card is put on hold.
Hotels typically use pre-authorisation as a form of security during your stay – in case you decide to sample items from the mini-bar, order room service or have additional charges for anything else you do there.
There are also many direct debit services and online companies that use pre-authorisations – such as Stan, PayPal and EziPay. When you register a new card or payment method with one of these services, you'll typically see a small pre-authorisation on your account. This helps the company confirm that your card is valid so that it can be charged for any transactions or subscriptions you set up.
As a pre-authorisation is not technically a charge, you will only see it in your "pending" transactions. In most cases, the funds from a pre-authorisation will be released within 1-14 days. However, an authorisation hold can technically last up to 30 days if it is not cancelled or completed before that time.
What types of credit cards are suitable for beginners?
In Australia, banks, financial institutions and different retail brands offer credit cards through the Visa, Mastercard and American Express payment networks. This basically means you'll see one of those logos on your credit card and can use it with any business that accepts that type of payment.
Beyond these basics, there are different types of credit cards to suit a mix of goals and needs. For instance, low rate credit cards have a low interest rate for purchases and often a lower annual fee, while rewards and platinum credit cards often charge high rates of interest and a higher annual fee.
If you're new to credit cards and want to get used to having one, it's worth considering a low-cost or no-frills credit card before upgrading to one with bells and whistles. Some options you might want to look at include:
- Low interest credit cards. Low interest rate credit cards make it cheaper to pay off a debt over time. These credit cards can also offer a low or 0% interest rate on purchases for a promotional period. Low interest credit cards are suited to beginners still finding their feet making repayments.
- No annual fee credit cards. This type of credit card costs nothing to own upfront. However, the rates of interest can be higher than low rate credit cards. A no annual fee credit card can sit in your wallet, never come out and it won’t cost you a thing. These types of credit cards are suited to beginners who are looking to build their credit history but don’t want to go all-out on a credit card with loads of features.
- No interest flat fee credit cards. First launched in Australia in 2020, these cards don't ever charge interest on your balance. Instead, there is a monthly fee of around $10-$22 when you use the card (as well as minimum repayments). This can make it simpler to work out how much you're charged each month, but it's worth using a credit card interest calculator to compare the cost of a no interest monthly fee credit card with other cards that charge interest.
- Student credit cards. If you're studying at university or TAFE and want to get a credit card, there are some student credit card options that offer lower costs than other cards.
What about rewards credit cards?
If the reason you want a credit card is to earn rewards as you spend, a key factor is making sure you get more value from rewards than what you spend on the card. This could mean choosing a rewards card with a low or $0 annual fee, making sure you pay off the entire balance each month (so you get interest-free days for purchases), choosing rewards based on their dollar value – or a mix of tactics. You can check out Finder's rewards credit cards guide to learn more about them and compare different options.
Compare low interest rate, no annual fee and student credit card options
How to apply for a credit card
Once you've found a credit card you want, applying is simple. Usually, you can fill in a secure application form online in around 10-20 minutes if you have all the key details handy. This usually includes basic identification details, your living situation, employment and other financial details including whether you have savings or other assets, what loans or cards you have and an estimate of your regular expenses.
Before you get started, you should make sure you're eligible to apply. The requirements vary between cards but we've listed some common eligibility criteria below:
- Australian residency status. Often you must be an Australian citizen or permanent resident. Some financial institutions will offer credit cards to temporary residents when they meet the visa requirements. You can learn more about credit cards for temporary residents in this guide.
- Income. Some credit cards list a minimum income requirement, such as $15,000 or $60,000 per year. Other cards require you to be employed, and some say you need to earn a regular income. There are also cards that don't list any income requirements, but even then you will need to have enough money to be able to make repayments.
- Age. You must be over the age of 18 to apply for any credit card in Australia.
- Credit history. If you have good or excellent credit history, you'll be eligible to apply for most credit cards. But if you have defaults, late payments, bankruptcy or other negative listings on your credit report, you usually won't be able to get a credit card. If you do not have any credit history, you won't be penalised but you may only be eligible for a low credit limit until you build up more good credit history.
You can find these requirements on the card review page or information page, as well as when you click to apply (before you start the actual application). Once you've checked that you're eligible to apply, you can click through to start the application.
As part of the application, you usually need to include some supporting documents to help verify these details, which we've listed below.
- Income information. You may need to provide copies of your most recent payslips or bank statements to prove your income. If you’re self-employed, you can provide your tax return instead.
- Identification. You will need to verify your identification with the credit card company before your application can be finalised. You can do this by providing your driver’s licence, passport or Medicare card number.
Most banks and providers will give you a response within 60 seconds of completing the online application and if you've been approved, you will receive your card in the mail about 10 days later. If you want to know more about applying for a credit card, check out this step-by-step guide to the process.
Dos and don'ts of your first (or any) credit card
Here are some mistakes to avoid and good credit card habits to get into:
- Make regular repayments. Credit cards are not free money. You need to make at least the minimum repayment every month so you can avoid late payment fees, stop your account from going into default and maintain a good credit history. However, you should always aim to pay more than the minimum to avoid being sucked into debt.
- Stay within your budget. Having a credit card means you can temporarily spend more money than you actually have. This can make it tempting to buy things you normally wouldn't. The best practice is to treat your credit card as if you were spending your own money, and if you need to spend more, to pay it off as soon as possible.
- Educate yourself. It's important to understand how credit cards work. For example, remember that ATM withdrawals count as cash advances and will immediately charge a higher interest rate. Or even if you have a 0% purchase or balance transfer offer on your card, you'll still need to make repayments each month and you can only take advantage of interest-free days when you pay your balance in full. Understand the fees and charges that come with most credit cards before you apply or at least as soon as you get your card.
- Make cash advances. When you use your credit card to get money from an ATM, gamble or to pay certain bills, you’ll be charged a cash advance fee of a couple of dollars as well as the cash advance interest rate, which can be as high as 29% p.a. Furthermore, interest-free days do not apply when you use your credit card for a cash advance.
- Share your credit card information. Apart from directly logging into your online banking or your bank's official app, do not enter your credit card information or log-in details into any email, text message or third-party website, with the obvious exception of making purchases from a trusted source.
- Apply for a credit card you can't really afford. For most people applying for their first credit card, this is a no annual fee or low rate credit card. Rewards credit cards can be a great way to get something for nothing, however, these products generally charge higher annual fees and interest rates.
If you still have questions about how credit cards work, reach out to us using the form at the bottom of the page and a member of the Finder team will be in touch.Back to top
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