Overview
A credit card is a small, rectangular piece of plastic that confers on its owner the ability to borrow money from a bank (or other lender) to use when paying for goods and services. (Even if you choose to pay with your mobile device, your bank still needs to send you that piece of plastic – for now.)
Repayment
On a due date specified by the bank, the credit card owner can choose whether to repay in full the accumulated balance of their purchases for the month, or make only a minimum repayment (typically 2% or 2.5% of the balance, or a fixed amount such as $5) and pay interest for continuing to borrow the remaining balance.
Payment due date
The due date for repayment usually falls between 14 and 25 days after the end of the monthly billing cycle. For this reason credit cards are often described as having ‘up to 44 days interest free’ or ‘up to 55 interest-free days’.
Interest charges
The money borrowed via the credit card, to make purchases, is free of interest charges from the date of the purchase transaction until the payment due date, provided the card account does not already have any carried-over debt from the previous month (such as an unpaid purchases balance or a balance transferred from another card).
If however, there is a debt carried over from the previous month, interest is charged on every purchase transaction, calculated from the transaction date until the repayment date. This applies unless there is an introductory offer in place which makes the purchases interest-free for a specified number of months, despite the carried-over debt – see ‘0% purchase credit cards’.
Clearly, the best way to use a credit card is to pay off the purchases balance in full every month, using the bank’s money totally free of interest charges for up to eight weeks after a purchase is made.
Interest rates
Credit card interest rates (charged on carried-over debt and also on new purchases where there is existing carried-over debt) are typically higher than the rates for other forms of borrowing, such as home loans and personal loans – in some cases very much higher. Credit card interest rates in Australia mostly fall in the range 10% p.a. to 22% p.a., although there are a few cards with rates lower and higher than this range.
Cash advances
If you use your credit card to make a cash withdrawal from your credit card account (either over-the-counter or via an ATM), this transaction is called a ‘cash advance’ and is never interest free. Interest is charged from the withdrawal date until the repayment date, even if there is no carried-over debt on the account.
Additionally, many cards have a cash advance interest rate that is higher — often by as much as 2% p.a. – than the interest rate charged on purchases debt.
Credit limit
All credit cards come with a credit limit, typically anywhere between $1,000 and $100,000. The card’s limit is based on the cardholder’s annual income and the bank’s assessment of their creditworthiness and ability to repay the amounts borrowed.
Once the card’s credit limit is reached (that is, once the total amount owing on the card is equal to the credit limit, or when the difference between the credit limit and the amount owing is less than the amount of an attempted new purchase), no further purchases can be made with the card until some of the balance owing has been repaid.
If you think your credit limit is too low, you can apply to the bank to increase your credit limit once you have had the card for a while and managed it responsibly, by making at least the minimum repayment on time every month and paying off large parts of the balance on a regular basis.
Annual fee
Many credit cards, especially those awarding rewards points on purchases and/or conferring complimentary benefits (e.g. free travel insurance), charge an annual fee. The fee can be anywhere between $30 and $1,500 or more, depending on the points and benefits attached to the card. However, some cards have no annual fee.
Credit card types
There are credit cards to suit the lifestyle and spending patterns of a wide variety of cardholders. Some of the most common types are:
- 0% purchase credit cards: No interest is charged on purchases for an introductory period, so the carried-over balance is interest free until the introductory period is over.
- Balance transfer credit cards: Special introductory interest rate (often 0%) for a specified period, on balances transferred from other cards.
- Rewards credit cards: Loyalty points, redeemable for rewards, are earned when purchases are made.
- Frequent flyer credit cards: Air miles, redeemable for flights or rewards, are earned when purchases are made.
- Low interest credit cards: Cards whose interest rate on carried-over debt is at the lower end of the scale.
- No annual fee credit cards: Cards with $0 annual fee.
Alternatives to credit cards
Although credit cards are very popular, and are the preferred payment method for online shopping in particular, they are not the only way to pay. Other ways to pay for purchases include:
- Cash. Widely accepted, but can be a security risk to carry around, and no good for paying online.
- Charge card. Similar to a credit card, but without the option to carry over a balance at the end of the month and pay interest on it. American Express offer several of these.
- Debit card. Looks like a credit card, but linked to your bank transaction account so that you pay with your own money.
- Prepaid card. A payment card used like a debit card, but preloaded with a fixed amount of cash rather than being linked to a bank account.
- PayPal. Online payment service that can be linked to a credit card, debit card or bank account. Especially popular as a form of payment on marketplaces such as eBay and Facebook Marketplace.
- Buy Now Pay Later (BNPL). Popularised by Afterpay and Zip in Australia, these schemes offer payment by instalments, with no interest charges but high fees if you miss payments.
- Personal loan. A good option for major purchases (furniture, appliances, technology, holiday) if you need time to pay, because the interest rate for a personal loan is usually lower than that of a credit card.
Credit cards vs debit cards
Both credit cards and debit cards have their advantages and disadvantages.
The benefits of a credit card are the possibility of using the bank’s money free of interest charges for 44 or 55 days (the length of time varies depending on the card), provided you always repay your account balance in full each month. Many credit cards also come with attached additional benefits, like rewards and frequent flyer points, free insurance, travel discounts and privileges, and other perks. Responsible use of a credit card can help improve your credit score. But credit card interest charges, if incurred, are mostly very high, and in the wrong hands a credit card is a temptation to overspend and end up in long-term debt.
Conversely, debit card users are far less likely to get into debt, simply because their spending is limited to the amount of money they have already earned and deposited in a bank account. They are not borrowing a bank’s money when they use their debit card (unless the debit card is attached to an overdraft account), but simply accessing their own funds in a bank account linked to the card. At the end of the month there is no bill to pay, and no interest charges to avoid. However, the vast majority of debit card users miss out on rewards points and other credit card benefits, and will not improve their credit score by using their card.
