Can credit cards still be our flexible friends?
Back in 2007, getting a credit card was pretty straightforward as the providers battled it out for our business. Long, interest-free balance transfer periods, attractive interest rates and high levels of cashback were there for the taking.
But, as the credit crunch took hold and the credit card companies discovered they’d been stung by a large amount of bad debt, this ready supply of cheap credit dried up. “It’s much harder to get a credit card now than it has been,” says Peter Harrison, head of credit cards at Moneysupermarket.com. “Lenders are being very cautious at a time when people’s risk profiles are worsening due to unemployment.”
As well as tougher conditions when it comes to being accepted for a card, interest rates are also edging up. According to Defaqto, the average monthly purchase rate has edged up from 1.26% in October 2007 to 1.29% in October 2009, overseas usage fees for Europe have risen from 2.66% to 2.79%, and the average cash advance fee has shifted from 2.56% to 2.75%.
“Credit card penalty fees for late payment, returned payment and going over your limit were capped at £12 in 2006, but there are other ways the card companies can increase their revenue,” explains David Black, banking specialist at Defaqto. “As well as increases to interest rates, we’re seeing the introduction of annual fees and dormancy fees.”
For example, American Express charges customers with its Platinum Cashback card a £20 dormancy fee if they don’t use it in a 12-month period. Similarly, Egg introduced a £1-a-month charge on its cashback card earlier this year.
“We’re also seeing more risk pricing coming into play,” adds Black. With this, if you’re accepted for a card, the provider will assess your credit rating and give you an interest rate to reflect it. “The best risks are rewarded with the lowest interest rates,” he adds.
You could also see your credit options reduce in other ways. Andrew Hagger, a spokesman for Moneynet.co.uk, explains: “Our customer feedback indicates that some of the credit card companies are cutting the credit limits on cards, especially where it hasn’t been used for a while. The banks have to include these credit limits on their balance sheets, whether or not they’re used, so if they can cut them, they will.”
However, although you might find yourself turned down for a card more often or struggle to get the deals you could have got a year ago, the providers are still keen to court business.
“We’re seeing card companies move into different areas of the market,” says Harrison. “Although some providers, such as Capital One, have left the balance transfer market, many now offer deals on new purchases instead. There are still plenty of offers available if you’ve got a good credit rating and you’re happy to shop around.”
Do you need one?
There are also considerable advantages to having a credit card. As well as giving you spending flexibility, credit cards also give you some purchase protection. Under section 75 of the Consumer Credit Act 1974, your credit card company is held equally liable with the supplier if you spend over £100 on an item. This means that if you don’t receive an item, or it’s damaged or faulty, you can claim back the costs from the credit card company.
But to get the most from your credit card, it’s essential to have the right card for your needs. What makes one card, or cards, better than others is determined by how you intend to use it. “Different cards will suit different people,” says Michelle Whiteman, a spokesperson for the UK Cards Association.
“Before you choose a card you should decide why you want it and how you intend to use it. Ask yourself questions such as whether you intend to pay off your bill in full each month, and whether your card is for emergencies, to spread the cost of spending, or to take advantage of a balance transfer deal.”
Balance transfer cards
Keeping a balance on a credit card is expensive. Taking the average interest rate of 17.4%, a £5,000 balance will cost you £870 over a year.
A 0% balance transfer card can take some of the pain out of this debt. Although the length of interest-free periods has fallen over the last year, the card enjoying pole position is the Virgin Money Mastercard, which offers a 16-month interest-free period.
There are costs involved. Most of these cards charge a balance transfer fee – for instance, Virgin charges 2.98% on its card.
“Balance transfer fees are usually around 3% with a minimum charge of £3 to £5,” says Hagger. “But they can still be worth paying, especially if you get a year or so of interest-free credit.”
Rather than finding a home for an existing balance, you may be looking for somewhere to spread the cost of a major purchase, such as a new car, a holiday or furniture if you’re setting up home. For this purpose, the ideal card is one offering 0% on new purchases.
Interest-free periods tend to be shorter on these cards than on those aimed at the balance transfer market, but you can still pick up a card that will give you a year’s grace. “Tesco has the best rate with a 12-month interest-free period, but there are also some offering nine and 10 months,” says Hagger.
If you do go for one of these cards – or a balance transfer card – it’s important to keep a note of when the offer ends so you can either clear your balance or move to another card before the interest rate goes up. For example, on the Tesco card, if you’ve got a balance after a year you’ll pay an APR of 16.9% on it.
If you’re the type of credit-card customer who clears your balance every month, you’ll enjoy paying nothing for your credit. But you could be missing a trick if you don’t get something extra from your credit card company.
“Even though you’re an unprofitable customer, only generating the merchant fees for the credit card company, there are still loads of rewards and incentives around,” says Harrison.
Some providers offer cashback as a percentage of your spend. For example, one of the more generous cards, Egg Money’s World Mastercard, offers 1% cashback on up to £20,000 a year. This means if you spent £1,000 a month, you’d receive £120 of cashback over the course of a year.
Rather than dishing out hard cash, some providers offer reward points. For example, Tesco’s credit card gives you one clubcard point, worth 1p, for every £4 you spend; Sainsbury’s gives two nectar points, worth 1p, for every £1 spent in the first two years; and the Lloyds TSB Airmiles Duo American Express card gives you one mile for every £10 spent.
“Some of these deals are great but make sure you’re going to use them. There’s not much point having a Tesco card if you don’t shop there,” adds Harrison.
Using cards overseas
Credit cards can be particularly handy when you go abroad, but some make better travel companions than others. Most will charge between 2.75% and 3% of what you spend as a foreign usage fee, although it is possible to avoid these costs altogether.
“The Santander Zero MasterCard and the Post Office Visa cards have no foreign usage fees, so you might want to consider getting one of these if you’re planning on using a card abroad,” says Hagger.
Another couple of cards to consider if you only plan to travel within Europe are the Nationwide Classic Visa and the Saga Platinum Card. These cards charge 1% outside Europe but are fee-free within Europe.
Low standard rates
If juggling rates and interest-free deals seems like too much of a hassle, or your credit card habits tend towards the erratic, a card with a low standard rate could be the most appropriate. You won’t get caught out if you forget to transfer at the end of an offer period and, if you don’t clear your card every month, you won’t pay too much for the privilege.
The cheapest standard rates come in at just over half the average credit card interest rate of 17.4%. For example, Halifax’s Easy Rate Mastercard has an interest rate of 8.9% and the Barclaycard Goldfish Mastercard charges 9.9%, although these rates can vary depending on your risk profile.
Credit card etiquette
As well as getting the right type of card for your spending habits, it’s also essential to understand credit card etiquette so you don’t fall foul of nasty charges or payment surprises.
First up are the charges. Credit card companies can hit you with fees for all sorts of misdemeanours, including late payments and going over your credit limit. Avoiding these takes a bit of planning but is relatively straightforward. For instance, to ensure you never miss a payment it’s worth setting up a direct debit to make at least the minimum payment each month.
Making payments on time can be particularly important if you’re on a balance transfer deal. Hagger explains: “If you miss a payment, the credit card provider is within its rights to cancel the deal. This could mean your interest rate rises significantly too.”
As well as making sure you avoid these charges, it’s also important to understand the payment hierarchy of your card. This refers to the order in which your credit card debt is cleared when you make a payment. The majority of providers use what’s called a ‘negative payment hierarchy’, where the cheapest debt, such as a 0% balance transfer or an introductory offer on new purchases, is paid off before the more expensive debt, such as cash advances.
It’s particularly important to check this if you’re on a balance transfer deal as it can be a very costly oversight.
“Because a credit card provider will usually apply your payment to the cheapest debt first, if you spend on a balance transfer, this will stay on your card – accruing interest – until you’ve cleared the transferred balance. To avoid this, cut up your balance transfer card and get another card if you’re going to make purchases,” advises Harrison.
This problem could soon disappear though. A White Paper issued by the government in July called for greater transparency in the credit card market. Its recommendations include higher minimum monthly repayments to reduce debt, scrapping credit card cheques, which usually have a higher interest rate, and a review into the payment hierarchy.
While greater transparency will benefit consumers, it’s likely to have knock-on effects. “The US has already moved to a positive payment hierarchy and it’s meant the end of 0% balance transfer deals,” says Harrison. “This could happen in the UK too.”
To get the most from your credit card it’s essential to find the right card, or cards, for your spending needs. That way, your card really can be your ‘flexible friend’.
Keep your plastic fantastic
• Set up a direct debit to make at least the minimum payment each month. This will prevent you being hit with late payment charges.
• Close any cards you don’t use. They could jeopardise your chances of borrowing money as potential lenders can view the credit limits on these as financial commitments.
• Never spend on a balance transfer card as a negative payment hierarchy can mean you’ll rack up interest until the transferred balance is cleared.
• Consider a deck of cards if you need to use your credit cards for different purposes, for example one for holidays, another to clear a balance and another for any purchases you want to make.
• Keep a note of when interest-free deals expire so you can move any balance and avoid an interest charge.
• Avoid using your credit card to withdraw cash. Unlike standard purchases, cash withdrawals are not eligible for an interest-free period and are often charged at a much higher APR.
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.
Moving money from one account to another, whether switching bank accounts or more likely transferring the outstanding balance on your credit card to another card that charges a lower – or 0% – rate of interest. Some card providers may charge a transfer fee that can be a percentage of the balance transferred.
This is used to compare interest rates for borrowing. It is the total (or “gross”) interest you’ll pay over the life of a loan, including charges and fees. For credit cards where interest is charged at more frequent intervals, the APR includes a “compounding” effect (paying interest on interest). So for a credit card charging 2% interest a month (equating to 24% a year), the APR would actually be 26.82%.