Understand how credit cards work, what they cost and everything you need to know about choosing the right one for you.
Maybe you’ve never had a credit card or maybe you don’t fully understand how they work. If this is the case, you can use this guide to understand the key features and standard costs of a credit card so you can find the right one for your budget and spending habits. You can also discover which types of credit cards are best suited to beginners, and mistakes you should avoid to get your credit card history off to a good start.
How does a credit card work?
A credit card is an unsecured revolving line of credit, meaning you can borrow money to make purchases without having to put up collateral. Based on your perceived ability to make repayments, credit card companies assign a credit limit, which is the maximum amount of money you can borrow. Unlike a debit card that uses your own money to make purchases, when you use a credit card, you are borrowing the bank's money. At the end of your billing cycle, you receive a statement and that tells you the total amount you owe for all of your purchases for that period. In the diagram below you can see the flow of money and information that happens behind the scenes when you use your credit card.
How credit card interest works
As you spend on your credit card, your debts will also begin to collect interest if you’re unable to pay the whole balance back by the end of the statement or interest-free period. If you’ve used your card for purchases, it will start collecting an interest charge (usually between 11.99% and 20%). If you’ve used your card for an ATM withdrawal or any other transaction that’s considered a cash advance, you’ll accrue the cash advance rate of up to around 22%. If you decide to balance transfer your debt down the track, you’ll also accrue a balance transfer interest rate (which is usually the same as either the interest rate or cash advance rate). Some cards do offer 0% promotional periods on purchases and balance transfers, so this is something to keep in mind during your comparison. Aside from interest rates, the main cost that comes with a credit card is the annual fee, which can vary from $0 to $1,200 p.a. depending on the card.
Each month, you’ll receive a statement that will detail the transactions you’ve made, the total outstanding balance you have and any interest you’re accruing. While you’re only required to pay a minimum repayment each month (2-3% of your total balance), it’s best to pay as much as you can. If you pay your entire balance in full, you can usually take advantage of up to 55 interest-free days in the next statement period. If you don’t pay your entire balance in full, the remainder will start to collect interest. If you miss the minimum repayment, you could be charged late payment fees.
What are the features of a credit card?
- Credit limit. This is the maximum amount of money you can borrow using your credit card.
- Interest and interest-free days. Interest is the cost to borrow money using a credit card. Interest varies depending on whether you’re using your credit card for a purchase or cash advance. Pay your balance in full by the statement due date and you get up to a number of interest-free days on purchases in the next statement period. Up to 55 days is the typical interest-free period.
- Balance transfers. A money-saving credit card feature, transfer your existing credit card debt to a new credit card with a different provider and get a special interest rate on the balance transfer amount for a limited time.
- Cash advances. Using your credit card to get cash from an ATM, for gambling purchases and paying some bills are cash advance transactions. Cash advances attract a cash advance fee.
- Rewards programs. A value-adding feature, get points in a rewards or frequent flyer program when you use your credit card to make eligible purchases.
- Contactless payments. For purchases under $100, tap your credit card against a contactless reader to complete a purchase in seconds.
- Extra features. Credit cards come with extras such as complimentary international travel insurance, purchase protection insurance, extended warranty and best price guarantee cover, complimentary airport lounge access, platinum concierge services and you can even get free wine when you use a Citi credit card to pay for a meal at a participating Citibank Dining restaurant.
What are the costs of a credit card?
- Repayments. You’re free to repay as much as you like as often as you like. You’re required to make the minimum repayment when your statement is issued. The minimum repayment is usually 2% of your outstanding balance. 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 to own a credit card. The annual fee ranges from $0 to hundreds of dollars depending on the credit card type. The credit card annual fee is deducted from your available credit 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; financial institutions have no recourse to take your assets if you default on your repayments.
- 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 types of credit cards are suitable for beginners?
In Australia, Visa, Mastercard and American Express issue credit cards with banks and financial institutions and even supermarkets. There are many types of credit cards with different features for different types of borrowers. Low rate credit cards feature a low purchase rate of interest and annual fee whereas rewards credit cards feature high rates of interest and annual fee, but also reward cardholders with points for purchases. It can be wise to begin with a no-frills credit card so you can get a grip on how credit cards work before upgrading to a product with bells and whistles.
These types of credit cards are suitable if you’re just starting out:
- Low interest credit cards. Low interest rate credit cards typically feature a low purchase rate of interest. This is beneficial if you don’t pay back your balance in full by the statement due date. These types of credit cards can also feature a promotional period in which you pay low or no interest on credit card purchases.
Low interest credit cards are suited to beginners still finding their feet making repayments. Paying off a debt over a couple of months is far cheaper with a low rate credit card compared to a rewards or premium credit card.
- No annual fee credit cards. This type of credit card costs nothing to own; 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.
- Low income credit cards. Low minimum income credit cards have a low credit limit. Typically your annual income must be about $15,000 or greater to service the minimum credit limit of $500. Low income credit cards are typically either low rate or low fee credit cards.
Low minimum income credit cards are suited to beginners who either have a low income or want a low credit limit to avoid the temptation to overspend.
- Student credit cards. Students looking to avoid paying a high annual fee and high rates of interest look towards student credit cards when comparing products.
How to apply for your first credit card
Credit cards are a product for borrowers with a good credit history. If you’ve never applied for a credit product before, you have a better chance of getting approved for a basic credit card than a credit card packed with extras. The credit card company will want to see copies of your latest payslips to verify your income as well as documents to verify your identity.
While most institutions require you to apply for a credit card in your own name, some also let you apply for a joint account with your partner. If you want to provide someone else with access to your account, you can also nominate additional cardholders.
The requirements will vary from card to card, but you can browse some of the standards below:
- Minimum income. This is how much you need to earn every year to be eligible to apply. Low income credit cards usually require cardholders to earn at least $15,000 p.a.
- Age. You must be over the age of 18.
- Residential status. You must be a citizen or permanent Australian resident. Some financial institutions offer credit cards to applicants with a student or temporary resident visa.
- Good credit history. You must have a good credit history to be eligible to apply. This includes no active defaults. If you do not have any credit history to date, you will not be penalised but you may only be eligible for a low credit limit. As you build credit history by using your credit card you can apply for a limit increase later on.
- Income information. You’ll need to provide copies of your most recent payslips 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.
If you still have questions about how credit cards work after reading this guide, reach out to us using the form at the bottom of the page; a member of the finder.com.au team will be in touch.Back to top