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Your essential guide to credit cards

17 December 2020

Credit cards can be a very convenient tool for budgeting and managing your finances – as well as a handy back-up in emergencies. However, understanding how credit cards work and putting good financial habits in place when using one is essential.

In this guide, we break it down by examining what credit cards are, how they can benefit you financially, and the pros and cons of owning one. Plus, we share how to avoid credit-card debt or manage it.

What are credit cards?

Essentially, credit cards give you a convenient way to borrow money or ‘credit’ from a bank that you’ll pay back later. You can use the credit to shop at a physical store or online; pay for items or make purchases while travelling overseas and you can also make ‘cash advances’ – withdraw money using the credit card. This is not the same as withdrawing money from a debit or savings account and may attract a fee. The terms and conditions on your credit card will help explain what fees you might pay if you use your credit card in this way.

Officially, credit cards are known as an unsecured ‘revolving line of credit’. You don’t need to put up any assets as collateral in order to have a credit card. You can use the money up to your set limit, but you must make regular repayments on what you’ve borrowed and the credit usually attracts a high interest rate.

A secured loan on the other hand would be a mortgage. The home is the collateral against which you are given the loan.

Why credit cards are helpful

Credit cards are super convenient – you might need to pay for a big-ticket item such as a plane ticket or a fridge and not have the cash to pay immediately. This is where you can use credit - if it doesn’t exceed your credit limit.

In terms of your financial footprint, using your credit card responsibly can be beneficial to your credit rating (also known as your credit score). A good credit score lets banks and lenders see how you manage your debts. For example: do you repay on time and meet your minimum payments. (Your credit score also assesses your payment of bills, such as mobile phone or utilities, like gas and electricity.) Using your credit card responsibly and having a good credit score may help you financially. For example, if you’re applying for a home loan, or asking a lender for lower interest rates, your credit-card behaviour can help the lender to make a decision about whether to approve your application.

A poor credit score, which can result from the misuse of credit cards, can negatively affect your ability to borrow money from a bank or lender. Your credit card limit is a potential debt and lenders may view it that way whether you use it or not.

If your credit score is poor the bank may choose not to give you a credit card if you apply for one because it could make your credit position – the amount you owe overall – worse.

Banks are required when lending to assess whether a loan to someone is “unsuitable”, based on whether you can repay “without substantial hardship” and that it meets your “requirements and objectives”.

Why people use credit cards

Some people use credit cards as a budgeting tool – they’ll make all their payments on the card/s and then pay it off every month. If used in this way, you can easily keep track of what you’ve spent on them from day to day.

However, others might prefer to keep a credit card in their wallet for emergencies only or for a purchase they don’t immediately have the cash for. For their day-to-day expenses, they might use a debit card.

Pros and cons

There are advantages and disadvantages to owning a credit card. Here’s a snapshot of what you need to know.

Pros of having a credit card

Convenient to carry and use and can be good for emergencies.

If you purchase via credit card and the me

Safer than carrying cash – if you lose cash, it’s gone, but cards can be cancelled

Credit cards allow for a reversal of a credit card transaction which happens when you dispute a purchase made with your credit card. Mostly, this is the result of you being dissatisfied with your purchase or there has been unauthorised or fraudulent activity/use of your card. Any transactions, processed without a proper authorization from the issuer, can also be returned as chargebacks.

They work in any currency so you can use them overseas without having to carry large amounts of cash on you

There are often perks attached such as reward programs that result in cash back or points which you can use to buy flights or put toward holidays

You can use them as a budgeting tool.

Cons of having a credit card

If you don’t pay what you owe off in full the interest compounds, making it harder to pay off. Interest rates can vary depending on the card. They may range from 9.99 percent per annum (p.a.) to 21.99 percent p.a. You can compare credit-card interest rates.

Check your terms and conditions. Cards may come with an annual fee and those fees can be expensive. Check for surcharges when you use credit cards to pay for things. Surcharges are applied by a business to cover the costs of processing payments. Fees and surcharges are an added expense.

Having multiple credit cards can impact your ability to borrow or get a loan because the limits on the credit cards are viewed as money you owe (potential debt).

Accessing money via cash advances can cost you in interest charges. These charges can be high.

You can be a victim of credit card fraud or identity theft. Look for credit cards that provide fraud protection.

You can be tempted to buy things on credit for which you don’t have money.

Credit card debts can spiral out of control and be very difficult to pay off.

How to avoid credit-card debt

Credit-card debt is common in Australia, and according to an ASIC report of 2018, credit card debt is a problem for more than 1 in 6 of us who have a card. About 70 percent of us have one card and 20 percent have two cards. Being aware of how debt happens and how you can manage it is key to avoiding getting out of control.

Here are some tips on good financial habits for credit-card holders:

Pay your credit card off in full every month to avoid interest charges. Interest rates range depending on the card you have opted to get. Understanding the card’s terms and conditions and the interest rate you’ll be paying is important for managing the debt.

Use unexpected funds, such as a tax rebate or inheritance, to put toward your credit-card debt to clear it. Prioritise paying off the debt with cards charging the highest interest rate first.

Don’t say yes to offers of increased credit limits if you know you’ll be tempted to buy things you couldn’t otherwise afford.

Maxing out your card (where you’ve spent up to the limit and are just paying the minimum repayments) isn’t great for your credit rating and can lead you into debt.

Building confidence as a credit card holder

If you’re considering getting a credit card for the first time, it’s a good idea to familiarise yourself with how they work.

Once you have it, take some time to read your first monthly statement carefully, getting to grips with the outstanding balance, the minimum repayment the bank wants you to pay, and when this payment is due.

Other things to be aware of include:

Interest free periods Essentially, an interest-free period is the number of days when no interest is charged on a new purchase – and how many interest-free days you get depends on when you buy something in your credit card’s statement cycle. If you have a 55-day interest free period and you make a purchase on the first day of the credit card statement cycle, you’ll have 55 days to pay it off before interest is charged.

Balance transfers A balance transfer is when you repay existing debt with a new credit card. It does not reduce the amount you owe. You would usually be transferring the balance to a new card with a lower interest rate so you can pay what you owe off faster. There will be a specific time in which you have to pay off the debt before the interest rate changes. There may also be transfer fees from the old credit card to the new. Balance transfer is not the best way to rid yourself of or manage debt unless you’re super diligent.

Cash advances While it can be handy to know you can withdraw cash from your credit card via an ATM, this ‘cash advance’ comes with drawbacks. Usually, interest is charged immediately on cash advance funds, and possibly fees on top as well. Check with your lender as to how your credit card operates so you can avoid racking up interest without realising it.

How to seek help If you do run into problems with credit card debt or need advice, contact your lender and let them know – sometimes they can organise a payment plan. You can also contact the National Debt Helpline for confidential, independent free advice – the website is here, or you can phone 1800 007 007 (the hotline is open 9.30-4.30pm Mon-Fri).

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