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Some of the different types of credit cards available in Australia include low interest rate, low or no annual fee, rewards, frequent flyer and balance transfer credit cards. So, how does a credit card work?
What is a credit card?
A credit card is a way to borrow money from a bank or financial institution. It gives you access to a ‘line of credit’, which means you can access money as needed up to a specified limit, known as your ‘credit limit’. You will need to repay any money you access, plus any interest, fees and other charges that apply.
Credit cards are issued by banks and other financial institutions. These providers issue credit cards in partnership with payment networks such as Mastercard or Visa. That means you can use the credit card wherever Mastercard or Visa is accepted. Another popular lender in the credit card space is American Express, who’s known for its benefits and rewards program for customers, but may be more limited in where it’s accepted for usage when compared to Mastercard and Visa.
How does a credit card work?
Your credit card provider will send you statements each month which will show the total amount of money you have spent, any fees or charges accrued, the minimum repayment and its due date.
If you pay off your balance in full by the due date each month, you won’t pay interest on your purchases. If you only pay the minimum repayment, you will typically be charged interest but you will avoid being charged a late payment fee.
Key credit card related terms
Credit limit: Your credit limit is the maximum amount of money you can borrow. When you apply for a credit card, the provider will determine your maximum credit limit based on the personal information you provide. Credit card providers usually set minimum and maximum credit limits, based on the type of card. Once you have a credit card, you can usually apply to increase or decrease your credit limit.
Minimum repayment: The minimum repayment is the lowest amount you have to pay to meet your credit agreement. If you don’t pay this amount by the regular due date, you will usually be charged a late payment fee. If you only pay your minimum repayment (rather than the full amount), you will generally avoid being charged a late payment fee, but you will be charged interest on your remaining balance. The minimum repayment amount will depend on your credit card provider and your outstanding balance.
Interest-free period: Credit cards typically offer an interest-free period on purchases, such as up to 44 or 55 days. This is the maximum period of time that you won’t be charged interest on new purchases you make with your credit card (starting from the first day of your statement period). If you don’t pay in full, you will lose your interest-free period and you will be charged interest on your unpaid balance. The interest-free period does not apply to other types of transactions, such as cash advances (when you withdraw money from your credit card account).
Fees: Credit cards can come with a range of fees, including annual or monthly fees, late payment fees, cash advance fees and international transaction fees. You can get low fee credit cards, which charge low or no annual fee. Generally, the lower the fee, the fewer perks the credit card will come with (such as rewards, frequent flyer points or complimentary insurances (i.e. purchase protection)).
Balance transfers: A balance transfer allows you to transfer the balance of your existing credit card (some or all) onto a new credit card, ideally with a lower interest rate. Some cards offer a 0% balance transfer, so you won’t be charged interest on your transferred balance for a limited time. But at the end of the offer, the interest rate may revert to a higher rate. You may also be charged interest on any new purchases you make.
What types of credit cards are there?
Now that you know how credit cards work you may find yourself wondering what the difference between all the different types of credit cards is. While all are still serving a similar function, each type of credit card has its own set of features:
- Low rate: come with lower interest rates, which can be good for those trying to minimise the amount of payable interest that may be charged on outstanding balances. Generally have higher annual fees than other cards.
- Low fee: lower fees make these cards good for those who expect to be able to pay off their balance in full each month. They often come with higher interest rates though.
- Rewards: allow you to earn rewards based on your spending. These rewards may come in the form of a cash back, retail discounts or frequent flyer points etc. These types of credit cards can come with higher fees and interest rates.
- Frequent flyer: specific kind of rewards credit cards linked to an airline rewards programs (i.e. Qantas rewards, Velocity frequent flyer etc.). Rewards points are transferred directly to your frequent flyer points account and can come with perks such as travel insurance and airport lounge access. They can also come with higher interest rates and fees.
- Balance transfer: balance transfer cards allow you to transfer your balances from other cards onto the one card. They typically offer a low interest rate for a period of time and can be useful if you’re trying to pay down your debt.
What is the difference between a credit card and a debit card?
The main difference between a credit card and a debit card is:
- When you use a credit card, you are borrowing money that you will need to pay back—plus any interest, fees and charges that apply.
- When you use a debit card, you are spending your own money that you already have in your transaction account.
How to apply for a credit card
To apply for a credit card, you will typically need to:
- Be 18 years of age
- Be an Australian citizen, permanent resident or hold an eligible visa
- Have a good credit history
- Meet any minimum income requirements specified.
You’ll typically need to provide information about your employment and income (such as payslips and bank statements), as well as information about your assets, debts and general living expenses.
If you’re interested in checking your credit score, you can do so for free with Canstar or via the Canstar App.
Before you apply for a credit card, make sure you carefully consider your personal circumstances and budget. Ask yourself: What will you use the credit card for? Will you pay off your balance each month? Will the annual fee offset any benefits you will receive? Could you pay for expenses in another way, such as by creating an emergency fund in a savings account?
Also consider the pros and cons of credit cards. Credit cards can be risky as they may charge higher interest rates than other forms of credit, such as personal loans, and you could damage your credit score if you don’t make your repayments on time. But if used responsibly, they could actually help you build a positive credit history and you may get benefits like rewards or frequent flyer points.
It’s recommended that you read the Product Disclosure Statement (PDS), Target Market Determination (TMD) and any other relevant documentation for any credit product you are considering. This can be obtained from a lender’s website or by contacting a lender directly.
