Play your cards right

BE SHARP WITH YOUR CARDS

Used properly credit cards can help us to afford things we want by spreading the cost. They can also be the easiest – sometimes the only – way to pay, both in person and online. If you take care of your credit cards and how you use them you can end up better off. But if you make a mistake or do not understand the way they work you can pay heavily for their convenience.

In July this year people in the UK owed £54 billion on credit cards. With interest rates averaging around 18% that means we are paying almost £10 billion a year in interest alone. Even those who pay off their card in full each month – about half of all cardholders – can end up paying money to the card company if they do not use it properly. But if you do understand the way credit cards work you can use the special offers the companies make to get yourself a very good deal.

No interest for a year
Many card companies attract new customers by offering them a zero percent interest rate on purchases. These offers always have a time limit – anything from three months to a year from when you first open the account. During that time you will pay no interest on the money you spend on the card. It can be a very useful way to pay for Christmas or a holiday by spreading the cost over a few months without paying interest on the debt. Always make sure you pay the debt off in full by the end of the offer. Then look carefully at the card’s terms and conditions – such as the interest rate (APR) and other charges – and decide if you want to carry on using it or choose another card.

Foreign use
Most credit cards charge you every time you use your card for a transaction in a foreign currency. That includes buying things over the internet from other countries as well as when you are abroad. Typically the cost is just under 3% of what you spend. Post Office Mastercards charge no fee anywhere in the world. And two others – Saga Platinum Visa card and Nationwide Visa cards – charge nothing in 36 European countries and just 1% elsewhere in the world. If you use your credit card a lot for foreign purchases it is worth getting one of these cheaper options.

When you use any plastic card abroad the retailer, restaurant or hotel may offer you the choice of paying in Sterling or the local currency. Always choose the local currency. If you choose Sterling the currency conversion rate will be worse and you may be charged extra fees. Much better to choose local currency and let Visa or MasterCard do the deal. It will always be cheaper for you.

Cash
There is one simple rule about using a credit card to get cash out of a machine. Do not do it. It is one of the most expensive ways to borrow money. First, you will be charged a fee – typically £3 but if you take out more than £100 or so then it may well be more. Second, all cards charge a much higher rate of interest on cash than on purchases – typically around 27.9%. Third, interest is normally charged from the moment the cash is dispensed. There is normally no interest free period (Saga Platinum Visa is an exception to this rule). With almost all other cards you will pay interest on cash you take out even if you pay your card off in full every month. And you will pay the next month as well because interest will be charged for the period between the bill arriving and the payment being made. You will also pay the following month because any payment you make will normally be applied to the debt with the lowest interest first. That means it is very hard to get rid of the high interest cash debt. In fact with most cards the only way is to over-pay by a few pounds. And if you do not pay your bill off in full each month the debt at its high interest rate can hang around for years.

Cashback
If you do pay your credit card off in full each month then you should consider getting a cashback card. These will pay you up to 1% on everything you spend. So instead of costing you money these cards give you a bit back. The card providers can afford it because every time a credit card is used the retailer pays a small fee. A cashback card shares some of that fee with you. There are very few cashback cards and they all have limits on how much spending they pay the cashback on. Egg Money even charges a monthly £1 fee so you have to spend at least £100 a month just to break even. A cashback card is only worthwhile if you use it for all your spending and, of course, pay it off in full each month without fail. If you miss even one payment a month’s interest will wipe out a year’s cashback. If you pay your bill by cheque remember that it will take several days even after the cheque has been received to be applied to your credit card.

Pay your card off
Credit cards are profitable because the banks are better at arithmetic than the rest of us. And that is seen most clearly with the minimum monthly payments they set. When you take out a card you are normally signed up automatically to pay the minimum off the debt each month. (You can of course change your direct debit to pay the full amount each month and if you can afford it that is sensible.) The minimum is set low – typically about 2.25% of the debt on the card with a minimum of £5. If you just pay the minimum it can take years to pay off a debt.

For example, you have a debt of £1000 on a card charging 18.9% APR (the average is 18.1%). You decide to cut up the card and repay the debt by making the minimum payment each month. It will take 21 years two months – yes 21 years that is not a misprint – before the debt is cleared. In that time the interest charged will be £1,512, far more than the money you borrowed. The reason is that each month the amount you pay diminishes until it reaches £5.

There is a simple way to cut this Gordian knot. Look at the minimum payment in the current month. In this case it is £22.83 (not £22.50 because the interest is added on before the minimum payment is calculated). If you can afford it this month you can afford it every month. So pay that amount every month in future. That will slash the repayment time to five years eleven months and cut the interest paid to £608. And if you can afford it why not double that monthly payment to £45.66? Then the debt disappears in two years three months and you pay just £218 interest. If you pay the minimum you could be in debt for life.

Changing cards
It can be difficult to change your credit card. Nowadays banks are much more fussy about who they will take on as new customers. Age, credit record, income, and whether you own your home can all mean an application is refused or you are offered a worse deal than the one advertised. So if you want to play with new cards, it is best to do it while you are still in work – and the younger the better!