How credit cards work – how they may affect your credit rating

Credit cards on top of paper bills

How do credit cards work?

A credit card allows you to borrow money to spend on the spot. You’ll typically have to pay back whatever you’ve spent monthly. Your spending limit is agreed on in advance with the lender, as is the rate of interest on any money that you owe if you don’t pay off the balance. There are different types of credit cards available.

Advantage: Protection

Under Section 75 of the Consumer Credit Act, the credit card provider will have the responsibility of making sure that you’re reimbursed if you don’t get what you paid for. For example, say you paid for a television using your card, and the company that you bought it from goes bust before you receive it – your provider should make sure that you get your money back. This typically applies for purchases between £100 and £30,000.

Disadvantage: Cash withdrawals

You may incur a charge whenever you use your credit card to withdraw cash, whether locally or abroad. This includes the use of ATMs and may extend to other uses, including buying travellers’ cheques and making payments to other accounts. Withdrawing cash (also known as a cash advance) from a credit card can have a negative impact on your credit score. Lenders may look at this unfavourably as it can be an indication of poor money management especially if there are multiple cash advances in a short period of time.

There are other potential advantages and disadvantages of having a credit card. You can view some of these here.

Credit cards and your credit rating

You’ll be expected to make monthly repayments on your credit card spending, including the minimum monthly amount charged by your provider. It’s important that you remember to pay this off as missed payments could affect your credit history – this could impact your ability to obtain credit if you’re planning to borrow money. 

Having a credit card could be useful in helping you to obtain credit – if you use it enough and make your repayments on time. This shows lenders that you’re able to make repayments on credit repayments promptly, which could help boost your creditworthiness when you’re applying to borrow money, such as for a loan or mortgage.

Having a credit card and showing that you can use it responsibly might help to improve your credit rating, if it’s poor. You may want to be aware, though, that your credit history will be assessed by the lender when you’re applying for a credit card – a good rating will typically help your application, and give you a chance at getting better interest rates.

If you’re planning on applying for a credit card, you may want to view your Equifax Credit Report and Score beforehand – it’s free for the first 30 days, then £14.95 monthly after that. The report will let you see if there’s anything in your credit history that should and can be improved, while your score will give you an indication of your creditworthiness.

This article was updated in April 2021; all information was correct at the time of writing.

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