Credit card, plastic, whatever you call it – the age-old debate of credit cards continues to resurface, especially now with services like Afterpay and Zippay coming into the picture. So, what exactly are credit cards? Are they being edged out to make way for these new services? And are they actually worth getting?
Let’s dive down into the world of credit cards to find out whether these plastic rectangles are worth the fuss.
What are credit cards?
Put simply, credit cards are issued by a financial institution and allow you to borrow funds like you would with a loan. If you are the cardholder, you agree to pay the bank back what you borrow, but with interest. According to Investopedia, there are four main types of credit cards; standard cards, rewards cards, secured credit cards and charge cards.
We take a look at these in more detail below.
A standard credit card is exactly what it sounds like; one without all the bells and whistles. It’s perfect for those who are after a simple, no-fuss card. Standard credit cards entitle the user to a certain amount of funds or credit, which can’t be accessed again until the credit has been repaid. For example, if your credit card has a $500 limit and you spend the full $500, you will be unable to use your credit card until you have paid those funds back.
Canstar describes rewards credit cards as a type of credit card that gives you extra benefits based on how much you spend. Your chosen lender will then convert your spending into rewards points, and once you redeem these points, they will convert them into rewards for you. The four different types of rewards include:
- cashback rewards in the form of cashback or gift vouchers;
- merchandise rewards that offer the customer a range of different options when choosing a reward, with points contributing to things like merchandise, gift cards, automotive, entertainment, lifestyle and more;
- frequent flyer points which suit customers looking for flights or travel; and
- instant rewards which give customers instant satisfaction through discount codes.
Secured credit cards
A secured credit card is usually opted for by people with little to no credit history or a bad credit rating. According to Nerd Wallet, the purpose of this type of credit card is to reduce the risk to the credit card issuer. It works by the borrower placing a cash deposit on the card – almost like a bond – that the issuer is entitled to if you can’t pay your bill. The deposit is usually equal to the credit limit on the card. For example, if the limit on the card is $500, the cash deposit to pay can be expected to be $500.
A charge card differs slightly from a credit card as there is no pre-set spending limit. However, the balance on the card needs to be paid off in full each month. Because of this, charge cards also have no interest, although if you do not pay off the balance in the month you will incur a fee.
How do they work?
Now that we’ve discussed what credit cards are, it seems only logical that we talk about how they work.
Credit cards have a set limit agreed upon by the customer and the lender which you can access to make purchases, almost like a bank loan but only when you activate it! Depending on what lender you are with, you usually have an interest-free repayment period – 30 days is common – where you can pay back the amount owing without incurring interest. Once it gets past this period, interest begins to accrue on the amount owing. The interest rate varies from lender to lender so it’s important to do your research before choosing which credit card to select.
Inovayt Financial Advisor Sunshine Coast Luke Saltmarsh advises, “Credit card interest is calculated as a percentage of how much you owe. For example, if you have $20,000 owing on a credit card for 12 months at an interest rate of 10 per cent per annum, then you’ll need to repay $22,000 which includes the $20k borrowed plus the $2,000 interest charged.”
Are they worth it?
Unfortunately, whether they are or aren’t worth it comes down to each individual and their needs.
Some of the benefits of having a credit card can include:
- Being able to make purchases if you are a bit short of money or waiting for money from payday to come in.
- The ability to take some strain off your bank account if needed.
- If you can pay off the purchase within the 30-day interest-free period, you won’t be hit with any extra charges.
- There is no time limit to pay back what you owe – however, you will keep accruing interest the longer you leave it.
- If you are hit with an emergency cost from something unexpected like a hospital bill or a car breakdown, having a credit card can take care of the surprise expense.
- Some lenders and companies offer rewards programs off the back of your credit card, which means you can gather rewards while you’re spending.
Some downsides to owning a credit card, according to Canstar, include:
- Interest rates – that pesky little thing we always seem to forget about or push to the side when thinking about purchases and expenses. The longer you leave your credit card bill the higher your interest piles up.
- Credit card fees are also a hidden cost that we don’t always take into consideration. Different type of fees includes late fees, annual fees, international transactions, cash advance fees and balance transfer fees.
- There is potential to hurt your credit score if you let your credit card debt snowball into something bigger than it should be.
So what does Luke advise? “Just plan ahead instead. If you do this, you shouldn’t need a credit card, as a credit card is an instrument that allows people to spend money they don’t have and essentially pay a cost for doing so.”
If you’re on the fence about whether you should get a credit card or not, have a think about your repayment habits and patterns, compare interest rates with different banks, find out how much the annual fees are and where you spend your money.
If you’re still not sure whether a credit card is right for you, get in touch with one of our financial advisor team members.