How credit cards work
A credit card is essentially a line of credit up to a specified limit (a credit limit).
Let’s say you apply for a credit card with lender A: they offer you a credit limit of $10,000. This means you can borrow up to $10,000 a month, borrow being the key word. This money needs to be repaid to the lender within a certain payment period. If it isn’t, you’ll be charged interest on the remaining balance.
Credit cards can be extremely useful, as they give you quick and easy access to a cash flow you might not have at that exact moment. But it’s the interest (plus fees) that can catch a lot of people out.
Interest on credit cards
Interest rates on credit cards vary significantly. While the rates on the more basic low rate and low fee cards can be less than 9%, there are cards that charge customers more than 20%. You’ll find that the average credit card interest rate tends to hover at around 17%.
It’s important to know that interest isn’t charged on all purchases made on a credit card, at least not straight away. There are some exceptions to this, such as purchases made on balance transfer cards (link to BT traps article) or if your card has no interest-free days (link to interest-free days article), but you’ll generally have until the end of your statement period to pay off your balance before you’re charged any interest.
The lower the interest rate and the higher the repayments you make, the less you’ll pay in interest.
Common credit card fees
As well as the interest rate, fees are another major consideration for choosing a credit card. There are a number of fees charged by credit card providers, and depending on the card you have they can really add up over the long-term.
Arguably the biggest and most well-known credit card fee is the annual fee, charged by the card provider to cover for the cost of keeping the account active, plus the cost of any features and benefits that card might provide. This fee can be $0 for your more basic cards, but annual fees over $700 and anywhere in-between are also the norm. The annual fee alone can make a card not worth using if it costs too much to simply have it in your wallet.
Other commonly found credit card fees include:
- Currency conversion fees
- Cash advance fees
- Balance transfer fees
- Late payment fees
- Over the limit fees
- Dishonour fees
- Over the counter fees
- Replacement card fees
What about credit card surcharge?
A credit card surcharge is basically just a slight additional fee charged by businesses to cover the cost of using a bank’s merchant service. These services are what allow customers like yourself to quickly swipe or tap your card to make a payment, and they’re not free for businesses to use.
The dollar amount you pay as a surcharge will ultimately come down to the card you’re using, the business and of course your purchase, but the RBA estimates that you’ll usually see a fee between 1% and 3%. It’s also not uncommon for your local coffee shop’s merchant fee to be less than 1%.
Credit limit: what is it?
A credit card credit limit is the maximum amount of debt you can have on your credit card at any time and is determined when applying for a new card.
Credit limit example: If your credit limit is $10,000, then you cannot have more than $10,000 in debt on the card.
Although you can indicate a preference for your credit limit, it’s ultimately your provider who will make the final decision, although they will take your request into account. To work out your credit limit, providers generally assess the following:
- Your income
- Your employment
- Your credit history and current debt levels
- The card itself
It is possible to actually go over your credit limit with some cards, but it’s definitely better to not. Generally, one of two things can happen:
- New transactions will be declined
- You may be charged a fee
Can a credit limit be increased?
You can choose to increase your credit limit if you constantly exceed it, but your credit card provider is under no obligation to accept your request. But you can increase your chances of being approved with the following tips:
- Use the card regularly. If you’re a proven credit card user, they’re more likely to want to keep you around over someone who used the card once a month.
- Have a good history of meeting repayments. A more responsible credit card user is more likely to be approved for a credit limit increase since they have a proven track record of not going off the deep end when it comes to credit card debt.
- Keep your expectations reasonable. Credit card providers have to carefully assess each application under responsible lending laws, so a more measured increase in your credit limit is more likely to get over the line than a massive one.
- Work on your credit rating. Take a bit of time to work on building your score and your repayments history, if you have been rejected previously, and you’ll probably have an easier go of it next time.
Tips on paying credit card debt fast
Here are some tips on how to get out of credit card debt:
- Pay more than the minimum repayments. If you’ve got a bit of extra cash squirrelled away in your savings, you might just have to bite the bullet and put it towards getting rid of your debt.
- Close each credit card account as you pay it off. Once you’ve paid off each credit card, why not remove it from your wallet?
- Lower your credit card limit. If you’ve got a history of regularly exceeding your credit card limit, you may want to consider lowering your credit card limit.
- Consider consolidating your credit card debt. Transfer your debts across to another credit card with a 0% balance transfer interest rate for a set period, or consolidate it through a personal loan or home loan.
- Get help from a financial counsellor. You can phone the financial counselling hotline on 1800 009 007 for help.
If you’ve got debt across multiple credit cards, consider either of the following strategies:
- Pay off the credit card with the highest interest rate first
- Pay off the credit card with the smallest debt first
How to stay out of credit card debt
Once you’ve cleared all that debt, the next step is to avoid undoing all your hard work by racking up another huge credit card balance.
- Only spend money you have
- Pay your balance in full every month
- Build an emergency fund
- Shop around for a low rate credit card
- Limit the number of credit cards you have
Denise Raward
Emma Duffy