How do credit cards work? A super simple explainer

How credit cards work: the basics

A credit card is a form of borrowed money (called credit). Your card issuer (usually a bank) approves your card with a credit limit. That's the maximum amount you can spend (borrow) on the card.

In technical terms a credit card is an unsecured revolving line of credit: unsecured because you don't provide any asset as security, revolving because you can use the card on an ongoing basis.

You use your credit card to buy stuff, just like you would with a debit card that comes with your bank account. The difference is: it's not your money, it's the bank or card company's money.

There are over 12 million credit cards in use in Australia.

Repaying your credit card balance

The money you spend on your credit card is added to your balance. You get a credit card statement each month that lists your total spending, how much you have to repay.

• The minimum repayment. This is the smallest amount you have to repay. If you don't pay the minimum you might get hit with a fee and eventually have your card cancelled.
• The closing balance. This is the total amount you owe. If you pay this all off then you have no card debt.

If you pay your card spending off in full each month then you don't get charged interest. If you don't pay it all off, then you'll get charged interest.

Are credit cards risky?

Yes and no. The biggest risk with a credit card is that it allows you to spend money you don't have and then avoid repaying it in full for a long time.

Many people make the mistake of getting a credit card, spending thousands of dollars and then taking months or years to pay it off. This hurts your credit score and costs you hundreds or even thousands of dollars in interest.

But if you have a regular income and you're financially responsible, a credit card isn't a bad thing. It helps you build positive credit history and gives you a flexible way to spend money.

Credit card features explained

That's the simple stuff explained. But credit cards are a little more complicated.

Here are the main features or components of a credit card.

• The purchase rate. The purchase rate is the interest rate that covers most card spending.
• The annual fee. Most cards charge a yearly fee. It can be under $100 or up to $400 for some cards. The higher the annual fee the more perks and benefits you get with the card.
• The credit limit. The maximum amount of money you can borrow on your credit card. This limit is determined by your income and credit history.
• Interest-free days. Most credit cards offer up to 44 or 55 days interest-free. The interest-free period gives you a bit of extra time to pay off your card spending before interest charges kick in.
• Cash advances. Using your credit card to withdraw cash from an ATM, make gambling purchases, buy foreign currency or pay some bills are considered cash advance transactions. These transactions incur a fee and a higher rate (the cash advance rate).
• Rewards and points. A rewards credit card gives you a way to get rewards when you pay by card. There are also cards that let you earn frequent flyer points, which is great for people who like to travel.
• Complimentary insurance. Some credit cards give you insurance cover on purchases or travel insurance.
• Balance transfers. If you've never had a credit card before, don't worry about this. A balance transfer offer is for people struggling with existing credit card debt. A balance transfer gives you an opportunity to pay off a card balance with a low or 0% rate.

How does credit card interest work?

The money you spend on a credit card attracts interest charges. But if you pay the full balance off before the interest kicks in you can avoid it completely.

Most credit card companies calculate interest on a daily basis and then add the charges to your account at the end of each statement period (month).

What types of credit cards are suitable for beginners?

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 (like rewards and platinum credit cards which have higher rates and fees).

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.

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).

How much will a credit card cost?

• Interest. If you pay off your card spending each month fully there's no interest. But if you carry a balance, you'll get charged interest.
• Fees. Most cards charge an annual fee. Some don't, or offer a fee waiver for the first year. As a general rule, the benefits you get from the card should outweigh the annual fee.
• Other costs. Credit cards charge fees for cash advance transactions (like getting cash out of an ATM with your card), and fees if you go over your credit limit.

So should I get a credit card?

Only you can answer this question. But here are some ways to think about it:

• Do you want to improve your credit score? Getting a low rate credit card with a low credit limit and making sure you pay it off each month is a good way to build credit history.
• Are you a disciplined or financially responsible person? If you're someone who is bad at keeping track of your money and forgets to pay bills, a credit card will probably get you into a bit of trouble. You need to be disciplined in checking each month and paying it off. Having all your cards and bank accounts with one bank, with one app, makes this a bit easier.
• Do you have really reckless spending habits? If you have poor impulse control and a history of bad buy now pay later decisions a credit card is probably a bad idea.
• Do you have a regular income and good financial habits? A credit card should be no trouble for you, and could be a good way to earn rewards or points.

Pros and cons of credit cards

Finder survey: Which of these credit card features would Australians of different ages like to understand better?

How to apply for a credit card

You can apply for a credit card in minutes. The first step is making sure you're eligible.

What eligibility criteria are there?

• Australian residency status. Some cards are only for citizens and permanent residents. But you can often get a card on a temporary work or business visa.
• Income. Some credit cards list a minimum income requirement. Other cards require you to be employed, and some say you need to earn a regular income.
• Age. You must be over the age of 18 to apply for any credit card in Australia.
• Credit score. If you have a 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.

What documents do you need to apply?

• Personal details such as your name, date of birth and address
• A valid form of ID, such as your driver's licence
• Employment and income details including recent payslips
• Other financial details such as information regarding assets, debts and liabilities

Frequently asked questions about credit cards

• Is it worth using a credit card in Australia?

  Many Australians choose to get a credit card to use in emergencies, to make big purchases or to collect rewards. However, whether it's worth getting will depend entirely on your own circumstances and what you would want to use the card for.

• What's a good limit for a first credit card?

  This depends on a few factors including your income and what you're planning to use the card for. As it's your first credit card, requesting a credit limit on the lower end of what you're able to get may be a good idea while you get used to making regular repayments and keeping your spending in check. You can always apply to increase the limit later on.

• What happens if I have a credit card but never use it?

  As long as you have no annual or monthly fees on your credit card, you shouldn't need to do anything. If you are being charged regular fees you will still need to make minimum payments to keep your card in good standing.

• 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. This is either as a form of security (as with hotels) or for companies to confirm your card is valid and can be charged.

  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.

Written by

Richard Whitten

Editor

Richard Whitten is a money editor at Finder, and has been covering home loans, property and personal finance for 6+ years. He has written for Yahoo Finance, Money Magazine and Homely; and has appeared on various radio shows nationwide. He holds a Certificate IV in mortgage broking and finance (RG 206), a Tier 1 Generic Knowledge certification and a Tier 2 General Advice Deposit Products (RG 146) certification. See full bio

Richard's expertise

Richard has written 554 Finder guides across topics including:

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Co-written by

Rebecca Pike

Senior writer

Rebecca Pike is Finder's senior writer for money. She joined Finder after almost four years writing for business publications in the mortgage and finance industry, including three years as editor of Mortgage Professional Australia. She regularly appears as a money expert on programs like Sunrise and Today, as well as across radio and newspapers. She also holds ASIC-recognised certifications in Tier 1 Generic Knowledge and Tier 2 General Advice Deposit Products. See full bio

Rebecca's expertise

Rebecca has written 197 Finder guides across topics including:

• Home loans
• Cost of living
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