Credit card Guides

10 things you should know about credit cards

By Emma Lunn editorial@consumerchoices.co.uk

Thinking about getting a credit card? Make sure you understand the basics first…(Updated 4/12/09)

The past few years have seen increased competition in the credit card market with consumers being offered everything from 0% balance transfer deals, interest-free credit on purchases, and cashback.

The most savvy consumers have taken advantage of these deals and switched cards regularly – so-called “rate tarts”. However, as a nation we’ve racked up a scary £1 trillion in personal debt, according to Datamonitor, and so it has become clear that credit cards have become a dangerous trap for many people.

So before you take out a credit card make sure you know what you’re signing up for. Below are 10 things you should know about credit cards.

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1. The length of the balance transfer

A number of credit cards allow you to transfer existing debts to the new card. These debts are then charged at 0% interest for a set period of time – and it’s important to know how many months this is.

Ideally you’ll pay off the debt during the 0% period and the debt won’t incur any more interest. If this isn’t possible it might be an idea to shop around for another 0% balance transfer card at the end of the interest-free period and move the debt again.

However good balance transfer deals are getting harder to find and you might not be accepted for the card you apply for. In some cases you’ll be better off going for a life of balance deal with a low fixed monthly rate, rather than a series of 0% cards.

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2. The balance transfer fee

Most cards are now charging fees for balance transfers. Some cards charge a flat fee but most charge a percentage of the debt.

It’s important to do the sums and take the balance transfer fee into account when working out whether switching to a 0% card is worthwhile.

For example, Virgin Money’s Credit Card (www.virginmoney.com) offers a 16 month 0% balance transfer fee with a fee of 2.98% of the balance. If you shifted a debt of £5,000 to the card the fee would equate to £149.

Again, a lot depends on the size of your balance and the length of time that it will take you to pay it off so think carefully before choosing your card.

3. You might be better off taking out a personal loan

While many consumers with good credit ratings have moved their money around between interest-free cards for years, there are a number of factors that should be considered. Owning many credit cards and only paying the minimum amount each month is looked upon badly by many credit reference agencies, and as highlighted above, you now have to pay to do this.

Also, 0% transfers should not be relied upon. If you’re one of the many people who move their balance every six months to avoid paying it off, you will be leaving a trail of credit cards behind you and could find that new cards will no longer take you. So it might be time to finally pay that debt off.

A loan offers a long-term structured method of paying off a debt that might have been lurking around for years – and rates can be much cheaper than credit cards.

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4. The order of payments

Although balance transfer cards offer 0% interest on debts transferred to the card, they’ll charge a higher APR for purchases. However, in most cases when you make payments the cheapest debts (ie. the 0% balance transfer) will be paid off first and the more expensive debt will continue racking up interest. This is called a negative payment hierarchy.

Let’s take the example of someone with a credit card which offers 0% on balance transfers and an APR of 18.9% on spending. If you transfer a balance of £1,000 to the card and make a purchase of £500, any payments you make will go towards paying off the £1,000 balance transfer first rather than the £500 purchase which will be accruing interest at 18.9%.

Before you apply for a credit card read the small print about the hierarchy of payments so you are clear about what’s going on. If possible go for one with a positive payment hierarchy – such as Nationwide - where you pay off the most expensive debt first.

Another option is to have different cards for balance transfers and spending. So transfer any existing balance to a card with an introductory 0% offer on balance transfers and use a different card for spending, preferably one with a 0% deal on purchases. Leave the balance transfer card at home when you go shopping; that way you won’t be tempted to spend on it.

5. The APR

The APR or annual percentage rate is the rate of interest you’ll be charged once any introductory offers have finished. APRs are supposed to be a way for consumers to compare different deals. Instead of 0% offers some cards offer low APRs for the lifetime of the balance transfer and/or purchases – and these cards can be worth going for if you don’t want to be constantly switching cards.

6. You shouldn’t take out cash on your credit card

Without exception, using your credit card to withdraw cash from an ATM is one of the most expensive ways of borrowing.

If you take out cash on your credit card you’ll start paying interest on the withdrawal straight away as there is no interest-free period (normally 56 or 59 days) for cash withdrawals. You’ll also be charged a higher rate of interest than you would for normal spending – sometimes as high as 30% APR. Finally you’ll be hit with a cash advance fee of between 2 and 3% of the amount, sometimes with a minimum charge too.

To add to this, banks are now beginning to widen the category of “instant cash transactions” – where money immediately leaves your account – to cover things like online gambling.

7. Pre-pay credit cards come with fees

This is a new kind of card aimed at young people and those not in a position to take credit. The pre-pay cards, which can be topped up in a shop, over the phone or online, use the Visa and Mastercard systems to offer a new way of staying on top of your spending.

While these cards mean that you can’t overspend, they do cost a lot. There are fees for opening the card, a monthly maintenance fee, transaction and loading fees and charges for using ATMs and for using your card abroad. These charges can take out as much as £5 for every £100 that you spend.

However, despite these charges, pre-pay cards are good for people who are bad with money – or for giving to teenagers, for example.

8. Some credit cards can help your credit score

Taking out a credit card can help you to build up your credit score. Having no history of borrowing money – and paying it back – can stand against you when you try to get a mortgage. So opening a credit card, even if you don’t use it much, is better than having savings and no credit history.

If, however, you already have a poor credit rating, with CCJs and defaulted payments, then you need to repay your outstanding debts before you can work on you credit rating.

Once you’ve done this, you could take out a card designed for people with poor credit. While the interest rates are extremely high – more than 50% in some cases, to reflect the risk they are taking with you – if you use it sensibly and stay on top of repayments you can rebuild your credit score.

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9. Cashback cards can earn you money

Cashback credit cards do exactly what they say on the tin - they give you cash back on your spending.

Different cards offer different returns depending on where you shop, so you should consider the amount of money you spend at the supermarket each month or on petrol for your car as this could determine which card is best for you.

However it’s important to make sure you pay off the balance on your card each month – otherwise the interest you’ll be charged will outweigh the cashback you get.

Compare cashback credit cards

10. You need to stay on top of credit card payments

If you’re late with your credit card repayments then you will be fined up to £12 (this was capped earlier this year by the OFT). While this might not seem like much, you also need to consider the damage you will be doing to your credit rating.

Setting up a direct debit to pay the minimum amount will save you from late payment fees and the detrimental effect on your credit score.

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