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Credit card guide
There are more plastic credit cards in the UK than there are people, yet few of us understand the intricacies of how credit cards work. But when used intelligently, credit cards can be enormously useful and can help anyone plan their spending in a cost effective way.
But a surprising number of people fail to make the most of credit cards and instead run up ruinous bills because they are confused by the myriad of plastic on offer and the complexity of the terms and conditions hidden away in the small print.
So a few minutes spent reading this guide could help you make the most of the advantages of credit cards and avoid the pitfalls of exorbitant interest charges and falling into serious debt arrears.
What's the difference between a credit card, store card, debit card and charge card?
A credit card enables you to make purchases and pay for them up to 56 days after the purchase was made, by making a monthly payment to clear the outstanding balance.
If you do this, the interest free period gives you time to get the funds ready to pay the next bill, during which time your hard earned cash can earn interest in your bank account.
debit card is usually linked to a bank current account and when used for purchases, the money is deducted from your bank account the same (or next) day.
A charge card will normally involve you paying a membership fee. It allows you to charge your purchases to an account which has to be paid off in full each month.
These are offered by retailers such as Next and Austin Reed. They are effectively a credit card which can only be used in the retailer’s outlets and are best avoided as they tend to charge exorbitant rates of interest (up to 30 per cent APR in some cases).
Affinity/ Charity card
These are like any other credit card, except that a charity receives a small amount of money when you open the account and a percentage of each purchase you make using the card.
These cards pay you back a small percentage of your total annual spend, but if you do not pay off the outstanding balance in full each month, the interest rate charges can soar.
How much should I pay off each month?
To gain maximum benefit from a credit card, it is best to pay off the entire outstanding balance each month. If you do not do so, you will start to rack up interest and possibly other charges.
But it is entirely up to you how much you pay off, although you are normally required to make a minimum payment of the greater of 3 per cent of the outstanding balance or £5 each month.
A few card issuers allow minimum payments of as little as 2.25 per cent each month, but clearly, the less you pay off, the more compound interest you are racking up on your account, so it is always best to pay off as much as you can.
If you use a credit card to withdraw cash you will be charged a higher rate of interest than for purchases and balance transfers, so using your credit card for this purchase is best avoided at all costs.
How is the interest calculated?
Different transactions are charged at different rates. For instance, purchases will normally be charged at between 0.50 and 1.7 per cent a month, giving an annual interest rate of between 6 and 20 per cent (although some cards charge more or less than this).
Some card issuers offer very low or 0 per cent interest rates for an introductory period of typically six to 12 months as an incentive for new customers to sign up. These can be excellent deals, providing you pay off the outstanding balance in full or transfer the balance to another card before the payment due date.
You should also check the rate payable once the introductory period comes to an end. For instance, the GE Money Master card which is currently offering a 12 month zero interest rate deal on balances and transfer, charges 14.89 per cent on both once the introductory period expires.
Balance transfers of existing debt to a zero interest rate card used to be free, but many issuers are now charging upfront fees for such transfers. For instance, GE Money is currently charging 2 per cent of the amount transferred, subject to a cap of £50.
Which type of card should I choose?
If you want to be a rate tart (someone who switches card at the end of each 0 per cent introductory offer), the best 0 per cent introductory deals are currently from the Master cards of GE Money (12 months), Marks & Spencer (12 months) and SkyCard (until 1 September 2007).
But if you don’t intend to pay off your outstanding balance each month, the most important feature to look out for is the annual percentage rate (APR) for purchases and balances transfers over the long term (often referred to as the ‘lifetime’ rate).
Currently, the lowest standard APRs are on the Visa cards offered by Halifax (5.9 per cent APR), Barclaycard (6.8 per cent APR) and Skycard (7.9 per cent APR).
If, on the other hand, you regularly pay off your entire bill each month, the APR is irrelevant as you will never incur interest charges. In this case, the rewards and benefits provided by some cards are more important. For instance, with a Goldfish card, you earn points every time you spend and can exchange these for discounts and vouchers which you can use at various high street retailers, such as Boots. Others, such as the Sainsbury’s Bank Visa card enable you to clock up air miles.
Some cards offer cash backs of 0.5-1 per cent of the amount spent, but there are often strings attached and in recent years card issuers have been reducing or withdrawing this benefit altogether.
For instance, the Alliance & Leicester Moneyback Visa card gives money back on purchases at a rate of 0.50 per cent up to £20,000, but only if you have an Alliance & Leicester premier current account or a mortgage with the bank.
Other cards offering the best cash back deals include Abbey Cashback credit card, American Express Blue, American Express Platinum, Bank of Ireland Moneyback Mastercard and Capital One Circle Rebate.
Cash withdrawals are usually charged at a higher rate of interest than for purchases and balance transfers.
For instance, the GE Money Master card charges 14.89 per cent APR for purchases and balance transfers, but 15.71 per cent interest for cash withdrawals, in addition to a 2 per cent fee. So a £200 cash withdrawal would cost you £4 plus 15.71 APR interest.
This means you should always avoid using a credit card for cash withdrawals and use a debit card instead. This is because cash withdrawals, as well as incurring a higher interest charge, start clocking up interest from the date of withdrawal, not the statement date.
Using your credit abroad can be expensive if you don’t watch out. Most credit cards charge foreign currency conversion charges of typically 2.75 per cent and other fees whenever you use the card abroad.
However, a few cards, such as the Nationwide Visa card and Lombard Direct, do not charge the foreign currency conversion charge and are highly recommended for use abroad or when purchasing items in a foreign currency. Otherwise, for withdrawing cash abroad from an ATM, it is best to use a debit card linked to one of Nationwide’s current accounts, such as its Flex Account.
If you require specialist services while abroad, there are a number of fee paying credit and charge cards such as American Express and Diners Card, but they are best suited to frequent travellers and those on business expenses.
Credit card issuers levy ’default charges’ for late payments (typically £15) or if you go over your credit limit (typically £12-£15). Administration fees for returned cheques or failed direct debits also cost around £15.
If you card issuer is charging you more than these amounts you should make a complaint as the banks have recently been ordered to limit these charges to an amount that reflects the cost of providing these services.Some cards also charge an annual fee, but these can be avoided as there are plenty of credit cards which don’t.
Credit card cheques
Like cash withdrawals, credit card cheques are best avoided. These incur handling fees, interest starts building up straightaway and the interest rate charged may be higher than for purchases.
Payment protection insurance (PPI)
Payment protection insurance is designed to help you pay credit card bills in the event that you are unable to work through sickness, redundancy or unemployment. But it is best avoided as it is expensive and only 40 per cent of claims are met. This is because it is often mis-sold, particularly to the self employed who are not covered.
PPI typically costs between 0.7 and 0.8 per cent a month per £100, so a PPI charge of 0.76 per cent will cost 76p per £100 of cover. Anyone taking out PPI cover and who makes only the minimum monthly payment each month could see their balance slowly creep up over time, even if no further purchases are made.
This is because many providers have cut their minimum monthly repayment requirement to 2 per from 5 per cent, so that a combination of PPI costing 0.70 per cent and the monthly interest charge, can in some cases be larger than the amount repaid.
Cards which consumers should beware of in this respect are Leeds & Holbeck building society’s Mastercard and the credit cards from Barclays, More Than and Create. Card issuers which require higher minimum monthly repayments ( and therefore avoid this conundrum) include MBNA, Abbey and Virgin.
How are payments applied to my outstanding debt?
The issue of how payments are applied is extremely complex, particularly if your debt consists of a mixture of purchases, balance transfers, cash withdrawals and fees.
This is because card issuers typically apply payments in the following order of priority (but you should check the terms and conditions of each card as terms may vary):
- Insurance premiums (for payment protection insurance)
- Charges or fees (for foreign exchange transactions, missing payments, copy statements etc)
- Balance transfers and promotional transactions (those with the lowest rates of interest first)
- Retail purchases
- Cash transactions
If you only make the minimum, or part, payment of your outstanding balance each month, remember that your payment may only cover the first two or three items on this list and may not cover any of your retail purchases or cash transactions.Generally speaking, issuers apply payments to items incurring the lowest rates of interest first and to the most expensive transactions last.
Credit reference agencies
Switching from one card to another at the end of each introductory deal is fine, but remember that each time you apply for credit, you leave a ‘footprint’ on your credit records which are held by credit reference agencies such as Experian and Equifax.
When you apply for a new credit card, the card issuer will check your credit history with these agencies to establish your record of applying for, and handling, debt.Very frequent applications for credit could count against you, but providing you have managed your debt responsibly, there should not be a problem.
You are much more likely to be rejected for credit if you have county court judgements against your name, have not lived at your current address for very long and are not only electoral role. A recent switch to self employment could also lower your credit rating. Factors that may boost your credit rating are being married, a homeowner (preferably for several years at the same address) and being employed (rather than self employed).
Theft, loss or misuse of your card
Identity fraud is a rapidly growing crime, so you should also file your credit card statement carefully in a safe place or if you are throwing it out, be sure to shred or burn it.
Always check your statement against your credit card slips to ensure that no one is using your card without your knowledge. Never disclose your PIN number to third parties and report lost or stolen cards immediately.
If your card is lost, stolen or fraudulently used, you should report it immediately to the card issuer by phone. You will not be liable for more than the first £50, providing you have not behaved negligently and will not be liable for any losses which take place after you have reported such events.
But be sure to confirm any loss, theft or fraud in writing to your card issuer within seven days as well. However, if your card is misused through your own fault, you may be liable for all losses.
Advantages of credit cards
Introductory zero per cent deals are a no-brainer, providing you have the discipline to set aside sufficient money to pay off the bill in full at the end of the nil charge term.
If you aren’t eligible for a 0 per cent deal (rising levels of debt have meant that card issuers are getting increasingly picky as to who can obtain these deals now), even a standard credit card deal can be cost effective providing you play by the rules and pay off your bills on time.
Some people rotate four credit cards with statement dates equally spaced out throughout the month so that they can maximise the interest free period on each card (ie by making purchases only in the week after each card’s statement date).
Credit cards accepting balance transfers can also be a great deal, providing you keep an eye on the small print. For instance, a low or zero rate of interest on balance transfers may only apply during the first few weeks and you may have to pay a transfer fee.For instance, balances of £2,500 or more transferred onto a GE Money Mastercard will cost you £50, and for lesser amounts 2 per cent of the amount transferred.
Credit cards can also offer valuable protection against breach of contract or misrepresentation by the provider of the goods and services. If the former refuses to pay up, you can claim from the credit card provider.
To claim redress under Section 75 of the Consumer Credit Act 1974, your purchase must have been made on a credit card (not a debit card, charge card or credit card cheque) and have had a cash price of more than £100, but less £30,000. Since March 2006, the Act has also applied to credit card purchases abroad as well.
If you are a heavy spender, you may benefit from any reward scheme on offer, whereby you clock up bonus points, air miles or cash back each time you spend on the card. But these schemes are usually graduated and often have a maximum ceiling spend.
Money you owe on a credit card counts as unsecured debt. This means it is not secured against your home, as mortgage debt and certain other loans are. So if you default on credit card debt, the card issuer will not be able to force you sell your home in the first instance, although if you are bankrupted because of other debts, your credit card debts will be taken into account by the insolvency practitioner.
Disadvantages of credit cards
Credit cards are extremely complex and can be a minefield for the unwary. Unless you are willing to take the trouble to understand how your credit card provider handles your debt, you should steer well clear.
As explained above, different types of transaction attract different rates of interest and payments are applied to your account in a strict order of priority. This means that if you do not pay off your bill in full each month, some elements will rack up huge amounts of interest because none of this debt is being paid off each month.
The combination of payment protection insurance and very low minimum montly repayments can be particularly pernicious and lead to spiralling debt for unsuspecting cardholders.