KNOW THE RULES - How credit cards work

Choosing the best card for you

Credit cards are an ongoing ‘line of credit’ that let you borrow money. You can use them for purchases and cash advances. You can repay the full amount borrowed each month or carry over part of the balance to the next month, with interest charged on the amount outstanding. This balance is then carried over to the following month, together with any new purchases.

Credit cards can be extremely useful and convenient. They are more secure than cash in your wallet, and can be handy when traveling – especially overseas. But they make it easy to build up debt quickly.

Using a credit card wisely involves choosing the card best suited to you, minimising the cost and keeping track of how much you owe.

The card that’s right for you will depend on your spending and repayment patterns, and whether you want to earn reward points. So, before you select a card, work out how you intend to use it.

If you already have a credit card you will have a good idea of your repayment patterns. If you are new to credit cards, you need to look at your current spending and budgeting habits to see how you would manage a card.

Do you pay your card off each month?

Card users who pay the full statement balance of their card each month by the due date are known as ‘transactors’. If this sounds like you, the interest rate will be less important, so opt for a card offering a generous interest-free period – usually 40 to 55 days. The date from which the interest-free period commences varies, being either from the date you make a purchase, or from the card statement date.

Payments need to be made by the due date or you could lose the interest-free period altogether – and potentially be hit by a late payment fee.

Do you carry over a balance each month?

These card users – also known as ‘revolvers’, pay only the minimum monthly repayment, carrying over some debt from month-to-month. This means you are likely to pay interest on the outstanding balance, so aim for a card with a lower interest rate.

Are you interested in a reward program?

Credit cards tend to come in two varieties: ‘No frills’ cards and those offering reward programs.

Basic, ‘no frills’ cards often have a low rate of interest, making them ideal for card users who continually carry an outstanding debt. They can also be a good idea if your card has a low credit limit as you may be unlikely to rack up sufficient worthwhile reward points. Note though, some no frills cards do provide free reward programs, most notably ‘instant’ rewards (see below).

Other credit cards provide incentives for customer loyalty through a variety of reward programs. The main types of reward programs are outlined below, but bear in mind these sweeteners often come at the cost of higher interest charges and annual membership fees. Be sure you will get value for money from these reward programs before signing up for one.

Don’t be tempted to let rewards influence your spending. Be aware too that earning rewards or cash rebates may encourage you to increase spending on your credit card.

‘Instant’ rewards

You may be able to get discounts with selected merchants when you pay with your credit card. Your card provider will provide a list of outlets where these ‘instant’ rewards can be obtained, and while there is usually no fee to access these rewards, it still pays to shop around to check that you couldn’t get a better price elsewhere.

‘Cash back’ rewards

Some credit cards will give you a cash rebate based on your level of card spending and/or your outstanding card balance. Depending on your spending pattern, this type of reward can provide a worthwhile discount, but do the sums first to make sure the discount doesn’t come at the expense of a higher interest rate or increased unnecessary spending.

‘Frequent flyer’ rewards

These reward programs let you accumulate membership points based on your card spending. The accumulated points can then be redeemed for free airline tickets.

Many frequent flyer programs charge a fee for program membership, and unless you use your credit card regularly, you may not get value for money from the scheme. The amount of card spending required to earn rewards varies between programs, and there may also be time limits applied to the points you acquire. Some card issuers may also cap the number of points you can accumulate annually irrespective of how much you use your card. If you are a regular card user, it may be worthwhile opting for a card that doesn’t impose this limitation.

Be aware also that it can be hard to redeem your frequent flyer points for travel during peak times like school holidays. This may not be a problem if you can be flexible with your flight dates, but if not, you may be better off paying for your air tickets and accumulating points for other purposes. Some programs allow you to redeem points with an associated travel agent so you can choose your own airlines or travel products (such as tours, or car hire or accommodation).

Another point to consider is your preferred airline. Opt for a card with access to the airline you use most frequently.

Above all, take a good look at the fine print on these reward programs. Make sure you are likely to get value from the program, and don’t let reward points influence your spending habits.

‘Zero rate’ cards

You may come across credit cards offering a zero interest rate on balances you transfer over from an existing card. These offers can sound tempting, but always look at the ongoing interest rate applied to new purchases. If it is far higher than the rate you are paying on your current card, a zero rate card may not be such a good deal after all.

What if you don’t want or can’t get a card?

For younger people who cannot get a credit card, or for those who choose not to use one, a debit card is a good alternative. Debit cards offer the convenience and security of a credit card, but they draw on funds in your bank account, so there is no interest charge.

A combined debit and credit card may offer the best of both worlds. Use the debit card for everyday purchases, and save the credit card for emergencies or to take advantage of discounts on large ticket items.