How do credit cards work?

Updated 16 February 2020

With 100+ different credit cards available, it’s perfectly reasonable to be confused about which one suits your spending habits, or if you need a credit card at all.

This guide takes you through the basics of a credit card, explaining low fee, low interest, balance transfers, cashback cards and rewards to help you pick the best card and avoid the many undesirable cards lurking around.

In this guide, we cover:

What is a Credit Card?

A credit card is a payment card that lets you spend by borrowing from the card supplier, who then sends you a bill at the end of every month.

All credit cards have a “credit limit” – this is the maximum amount you can borrow. Your credit limit depends on your income, credit score and general financial health. Not everyone who applies for a credit card is given one – many factors beyond your income are taken into consideration.

If you spend with a credit card, you will be charged interest. However, if you pay back what you borrowed to spend by the due date, the interest is zero. Interest rates are usually between 15% and 25%.

Who can get a Credit Card?

Anyone over 18 years of age can apply for a credit card. Usually, students will receive a credit limit of $500-$1,000, which reflects the low or zero income students have. Working adults will have greater choices as to credit limits and benefits. You can apply for more than one credit card; your chance of success depends on your credit history and financial standing.

What is a “Balance Transfer” credit card, and how does it work?

To be eligible for a balance transfer credit card, you need to have an existing credit card with money owing. A balance transfer credit card is a new credit card that allows for an existing card’s balance to be transferred to it. The purpose of the balance transfer credit card is that it offers a low interest rate (or 0% in some cases) so you can repay it with much less interest cost that your existing credit card. Balance transfer credit cards are suitable for people having some difficulty in repaying their credit card every month. By paying low or no interest, the total debt can be paid off faster.

How do “0% interest rate” credit cards work?

0% interest is also known as 'interest free'. You can make purchases on the card and pay no interest for a set period of time (i.e. until the balance is due). As is the case in New Zealand, GEM Visa and Q Mastercard both offer extended 0% periods beyond the standard 45-55 interest-free days offered by traditional credit cards.

0% interest offers are advertised to entice people to sign up and incur debt. But they do have their place - if you want to make a large purchase and pay for it over a set period, such as six months, they can make the purchase much cheaper than a short-term loan etc. But only if it's full repaid in full at the end of the interest-free period. If you don’t do this, the remaining debt becomes expensive.

How do airline award credit cards work?

Airline award credit cards earn you points towards a flight every time you spend on the card. The most popular airline credit card partner is Air New Zealand and its Airpoints Dollars program. The cards usually have annual fees (but some don’t) and rely on big spends to earn enough points for a free flight. As with any credit card, you need to pay them off in full every month. If you don't, the interest charges will outweigh the value of any airline award points.

How do cashback credit cards work?

Cashback credit cards pay you to spend on them. While it’s not a large amount, you can expect 1% back on your annual spend. This means a $100 credit on your account if you’ve spent $10,000. As with any credit card, you need to pay the full balance of a rewards card every month. Otherwise, the interest charges will outweigh the value of any cashback reward.

The 12 Sacred Rules of a Credit Card

Credit Cards are Very Expensive if Not Paid Off

Making the minimum payment will mean the remainder of the balance will be charged a huge amount of interest. For example, taking 12 months to pay off a $4,000 balance will cost around $800 if the interest rate is 20%. That’s HUGE.

If you don’t pay a minimum payment, there are more fees coming

Late payment fees are just the start. Your card will also go to the collections department of your credit card issuer, meaning a lot of hassle and contact to get the balance.

Credit cards cannot be paid off with other credit cards

This question is asked a lot, but there is no possibility of paying off one credit card with another. Your balance must be paid off with money in your bank account.

Charge only what you can afford to pay off

Be happy and live within your means. If you can’t afford it in 4 weeks, don’t buy it.

You can move your credit card debt if you need to

There is no obligation to stay with a credit card if you are being charged more than you need to be. Look for a balance transfer deal which will at least reduce the interest costs.

But, don't get too excited by balance transfers

The debt you incurred and transferred still needs to be paid. Low or zero interest doesn’t last forever, so paying off a card is a big priority.

Choose cards like a winner

Low-interest credit cards are perfect if you sometimes can’t pay them off, or look for generous rewards and flight benefits if you always pay your credit card on time.

AVOID being a slave to rewards and perks that aren't worth the cost

Don’t spend more thinking it will make you better off – the benefits from a credit card are rarely ever above 2% of what you spend, so don’t get caught out overspending.

Don't get too many credit cards

The more cards you have, the more temptation you might have to use them. Also, having several cards is harder to manage and budget for. So keep it light and simple with one or two cards max.

Audit your statement every month

A credit card often has things in it you don’t need to pay for, like automatic renewals you don’t want or memberships you don’t need. Don’t be afraid to relive the past: go line by line through your bill and highlight anything that’s wrong or you can live without.

Don’t withdraw cash on your credit card

The interest is high, and you get charged it from the minute you take it out of the machine. Also, you don’t earn any rewards or cashback on it.

Don't use credit cards if you will abuse them

If you don’t have self-control, stick with cash. Buying stuff may seem like a good idea, but debt can spiral and cause misery. Be smart; be safe.