Are you using the best payment method for your spending?
Between credit cards, debit cards, overdrafts and loans, there are so many ways to pay for things.
Understanding when to use each of them will help you to make smart decisions about your finances and put yourself in the best position for any future finance goals.
In this guide, we’ll explore how credit cards compare to other payment methods, to help you decide which is right for your needs.
What is a credit card?
So, what is a credit card and how does a credit card work? A credit card is a payment card that allows you to borrow money to pay for goods and services.
Any money borrowed by paying with the credit card will be repayable to the card provider. You need to make at least the minimum monthly repayment and will be charged interest on anything left outstanding.
When credit cards are useful
Credit cards are useful as they allow you to be more flexible with your spending, which can provide a number of benefits and use cases. Some of the main advantages of using a credit card include:
- Covering unexpected payments and purchases, whether paying for an emergency repair on your boiler or covering a stray bill at the end of the month. You can use the credit card to pay for the expense, and repay the amount in the next month.
- Consolidating multiple debts into a single, more manageable balance. This can help to provide a greater sense of control over your finances.
- Protection on payments over £100 and up to £30,000, under the Consumer Credit Agreement. This means that the credit card provider is equally liable, should there be an issue with your purchase.
- Rewards, perks and loyalty programs offered by card providers allow you to earn points for using the card, which can then be redeemed for rewards.
- Improving your credit score yes that’s right a credit card can improve your credit score by showing lenders that you are a responsible borrower, regularly using the credit card for purchases and paying-off the balance on-time.
Credit card considerations
Like any borrowing product, credit cards come with some considerations to keep in mind:
- Missing a payment can reduce your credit score
- If you only make the minimum monthly repayment, rather than trying to pay off the full balance, the amount of debt you owe could build up over time
- It’s important to use your credit card wisely and avoid spending outside your means, to be sure you can repay the debt comfortably.
Things to consider when deciding on a borrowing or credit product
How much do I need to borrow?
The amount you will need to borrow will have an impact on which payment method is most appropriate. For example, home improvements costing thousands of pounds might be better suited for a personal loan than dipping into your overdraft. Similarly, if you only need a few pounds to cover a bill before the end of the month, then an overdraft or credit card might be more suitable.
How much will this way of borrowing cost me?
Whenever borrowing money, the lender will generally charge interest so that they can make money from the service. Different forms of borrowing and even different lenders will come with varied levels of interest and terms.
Once you know how much you need to borrow, you can look at the interest rate and repayment plan offered by each lender. You can then use this to calculate the total cost over the duration of the repayment schedule, to see which will work out best for you in the end.
What is the money going to be used for?
Another thing to keep in mind is that some payment methods are more suitable than others for specific types of spending. Large purchases benefit from the additional protection offered by credit cards. Smaller everyday purchases are easily covered by an overdraft or credit card. Bank transfers on the other hand are better suited for an overdraft.
Credit card vs debit card
Debit cards are one of the most common payment methods in the world, but how do they differ from credit cards?
What is a debit card?
A debit card is a payment card that directly uses money from your bank account to pay for items in shops and make withdrawals from cash machines.
How do debit cards work?
When you’re at a point of purchase, whether at the checkout in a shop or paying the bill after a meal out, you will often be presented with a card machine. Tapping your contactless debit card, or inserting it and entering your pin, will trigger a direct charge to the bank account associated with that card. When paying online, providing your card details to the seller will allow them to charge your bank account in the same way.
What’s the difference between a debit card and a credit card?
While a debit card charges your bank account directly, making use of your existing balance, a credit card will have the card provider pay for things up to an agreed limit. You will then need to repay the debt to the credit provider based on the terms of the account.
Features and benefits of debit cards
- Withdraw cash at an ATM and in bank branches
- Setup direct debits and regular payments
- Uses your own funds, meaning there are no repayment terms to stay on-top of
When is a debit card preferable over a credit card?
Debit cards are generally best-used for small everyday expenses that you’ve budgeted for. They’re also a good choice if you are needing to live within your means without relying on borrowing.
Examples of scenarios when a debit card might be preferable include:
- Everyday small purchases like coffee, public transport, or groceries
- If you want to keep a close eye on spending and live within your means
- If you’re in the process of paying off outstanding debts
Credit card vs overdraft
Similar to debit cards, overdrafts are commonly seen in bank accounts, making them an easily accessible option when you find yourself short on cash.
What is an overdraft?
An overdraft is an amount of money, up to an agreed limit, that your bank will allow you to be in debt. This means that you can continue to use your bank account and debit card, even if you have no money left in your account.
How do overdrafts work?
An overdraft is essentially a form of loan directly from your bank.
You can ask your bank for an overdraft, or your account might come with one by default. They can either be “authorised”, meaning the bank has approved it in advance; or “unauthorised”, meaning that more money was spent than what was available in the account, without agreeing it with the bank first.
Overdrafts will come with charges and terms, just like any other form of borrowing. As of April 2020, the interest and fees for an authorised and unauthorised overdraft are the same, generally between 19% and 40%.
What’s the difference between an overdraft and a credit card?
Overdrafts and credit cards are both forms of personal credit. While an overdraft is generally directly linked with your current account with your bank, a credit card could be from a variety of providers.
An overdraft can act as a safety net, for times when you have unexpected cash flow problems and need to make ends meet before your payday.
Whereas a credit card is typically more suitable for short-term financing of large purchases, providing additional securities and benefits.
Features and benefits of overdrafts
- Overdrafts are flexible, you only borrow what you need at the time
- Quicker and easier to arrange than applying for a credit card
- Unlikely to have fees for paying-off early
When is an overdraft preferable over a credit card?
If you’re finding yourself short on cash due to an unexpected bill or just making ends meet in a busy month, then an overdraft can help you to cover the costs.
If you’re planning a large purchase of over £100, then a credit card will offer you additional protection on the transaction. Regularly borrowing and repaying with a credit card will also help to improve your credit score, by demonstrating that you can borrow responsibly.
Credit card vs charge card
While you may well have heard of a credit card, debit card or overdraft before, you might not be so familiar with charge cards.
What is a charge card?
A charge card works like a credit card, only it requires you to repay the borrowed amount in full each month. This means that the debt cannot be spread over a number of months and must be repaid in full by the agreed monthly due date.
How do charge cards work?
Charge cards will typically be used for high-income individuals or business expenses charged to a company account.
They are not designed to be in-debt for more than a month and so they typically don’t have interest rates. Instead, they will usually come with annual fees, fees for cash withdrawals and fees for spending abroad.
If a payment deadline is missed, the card provider will typically apply additional late fees to the account, or high-interest charges on the amount in debt.
Because of their unique nature and use cases, charge cards are less widely accepted compared to more common payment methods.
What’s the difference between a charge card and a credit card?
Credit cards allow you to be flexible and repay the amount you’ve spent over a series of monthly repayments, but as a result have stricter limits on how much you can spend.
Charge cards will typically not have a limit on how much can be spent each month, but require the amount borrowed to be repaid in full before the agreed monthly due date.
Features and benefits of charge cards
- No interest to pay for normal use
- There is often no credit limit
- Some offer rewards or discount schemes for regular usage
- Charge cards can help businesses monitor expenses
When is a charge card preferable over a credit card?
Generally speaking, a charge card is not going to be suitable for personal use in most cases. They are best suited to situations where multiple people need to access the same bank account, and it’s important to keep track of each person’s spending. This is why charge cards are popular for business expenses.
Credit cards offer similar benefits, while being more flexible and suitable for personal use.
Credit card vs personal loan
Personal loans are one of the most common forms of borrowing when it comes to funding large purchases, life events or consolidating debts.
What is a personal loan?
A personal loan involves borrowing money from a lender, which is then repaid with interest over a short-to-medium term.
How do personal loans work?
Personal loans are generally unsecured, meaning they are not tied to any assets such as your house.
To take out a personal loan, you must apply to a lender, who will then review your credit report and decide whether to approve you based on their eligibility criteria.
Once approved, you will receive the requested amount in your bank account. You will then be required to repay the borrowed amount over a set period of time, usually with fixed payments each month.
If you miss a payment, the lender might charge additional interest on your debt, increasing the amount owed. Like other forms of borrowing, missing a payment can also negatively affect your credit score.
What’s the difference between a personal loan and a credit card?
A personal loan is a lump sum, which you request from a provider and usually start repaying immediately once you’ve received the money.
Whereas a credit card will often be more like a revolving credit line, that you can flexibly use and repay whenever you need it, with no fixed term or repayment schedule.
You can read more about the differences between loans and credit cards in our full guide.
Features and benefits of personal loans
- Will often have lower interest rates than credit cards
- Fixed monthly payments can be easier to budget for and stay on-top of
- Some lenders provide fast funding, approving large sums of money quickly
When is a personal loan preferable over a credit card?
If you’ve got a large expense coming up, like a wedding, a new car or an extension to your home, then a personal loan can work well to cover the cost.
Credit cards are better suited when you need access to moderate amounts of cash every once in a while for medium-to-large purchases, like a TV or sofa, which you can afford to pay-off over the following months.
However, that isn’t to say that you can’t use a credit card for a new car, or take out a loan to pay for a TV. All are viable options, depending on your preference and circumstances.
Which financial product is right for you?
No matter how you choose to pay for your spending, there is no definitive “best” option.
Some might offer greater benefits for a given use than others, but it ultimately comes down to what you are most comfortable with.
In fact, it can often be helpful to use a combination of a few forms of finance, so that you can be flexible to any situation and confident that you’ve got the right tool for the job. This can also help to boost your credit score, by showing lenders that you can responsibly borrow from a variety of sources.
If you’re thinking of taking out a loan, we can help out. To get started, head to our personal loan eligibility checker.
If a credit card feels like a better fit for your needs, then head to our credit card finder tool to start comparing deals.
Want to know more? Check out our credit card FAQs:
Take a look through our recommended credit card lenders including credit cards by Zopa, 118 118 and more lenders, to find out which type of credit card is perfect for you.
