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Credit Cards Explained

1st November 2010

Credit cards have become a part of everyday life; almost all of the adult population now own at least one. There are many advantages available for cardholders, such as the ability to make transactions online and quickly in store, as well as security against theft and an easily-accessible supply of credit.

But those who are new to the world of credit cards may struggle to understand exactly how they work. The baffling terms associated with credit cards can also cause confusion. Here, we aim to demystify credit cards in order to provide you with a better understanding of what they are all about.

Basically, credit cards are keys to bank accounts, in which you can store your money. Then when you come to buying something, instead of having to pay in cash, you can simply whip out your card and insert in into a machine. The money will then be taken out of your credit card account.

You may be wondering: but what if someone steals my card? Can they just go along and freely purchase goods on it? The answer to this question is no - credit cards each have their own pin code, a four digit code (like a password) known only to the cardholder. To use a credit card, you must enter its pin code on a number pad, or the transaction won't go through.

As well as being able to spend your own money that you have put into your credit card account, you can use the set amount of credit your card offers. So essentially, you are borrowing money from the bank your card is registered with. Of course, this service is not free of charge: you must pay interest on any money you owe.

The amount of interest you have to pay is determined by the APR rate of the credit card. APR stands for 'annual percentage rate'. As you have probably guessed, the lower the APR rate of a card is, the lower the interest rate will be. In general, when shopping round for a credit card you should select one with a low APR rate, to save you money - however, you must also look into any other charges the card may have, such as administration and legal fees. Some cards even charge you a penalty for paying a loan off too early (because this way the bank has made less money off you from interest) - it is worth bearing this in mind too.

Many cards have something known as an interest free period. This is the amount of time (usually a number of days) that you can borrow money on the card without having to pay any interest. Having a reasonably large interest free period can be of advantage to you: by paying the money you owe back before the time is out you will avoid any interest charges.

Once you have used some credit on your credit card without paying it back, you will normally have to pay it back in instalments. These can be as big as you like: but not as small as you like. Credit cards will have a set minimum payment (usually around £5). You must pay at least this amount back every time a payment is due, or you are at risk of damaging your credit rating.

Although they sound complicated, credit cards are relatively easy to use once you are familiar with the process. When opting for a credit card, choose one that will suit your needs, and make sure the APR rate is relatively low - but look carefully for hidden charges.