Choose the right credit card for you
We are a nation of credit card junkies: more than £132 billion was spent using credit cards in 2009, despite an average interest rate of a whopping 18.9%, according to Moneyfacts. However, used correctly, credit cards can be a powerful financial tool.
Andrew Hagger, a spokesperson for financial comparison website moneynet.co.uk, says: "They can help with cash flow and offer you protection under section 75 of the Consumer Credit Act 1974 when you buy goods worth between £100 and £30,000. And they don't have to cost much – if anything – provided you pick the one that's right for you."
Read our round-up of the best credit card rates
Following consumer pressure, after interest rates started rising steeply, the government and the credit card industry have agreed a number of rule changes that will improve credit card customer rights. The new regulations came into force at the start of 2011.
The most important rule change affects the way debts are paid off. Traditionally, most credit card companies have allocated payments to the cheapest debt first – a practice known as 'negative payment hierarchy' – against the interests of card holders.
So if you had transferred a balance to a 0% card and then spent on the card, repayments would be used to clear the transferred interest-free balance, leaving interest mounting up on the spend.
However, from January, card companies have to settle the most expensive debt first - 'positive payment hierarchy'.
Another rule change will affect minimum payments. New customers will have to repay a minimum sum, comprising interest, fees and charges plus 1% of the principal debt, to encourage better repayment practice. Current minimum repayments vary greatly but can be so low that a debt lingers on for years.
For example, someone paying back the minimum (in this case, the greater of 2.5% or £5) on a debt of £1,000 on a card with an APR of 18.13% would take 17 years to clear their card and pay £1,113 in interest, according to moneysupermarket.com.
"This change will benefit new cardholders, but it won't apply to existing customers, as some could see their repayments increase dramatically," warns Sandra Quinn, spokesperson for the UK Cards Association.
You can also now expect to receive an annual statement that will enable you to compare your card with others on the market. Card companies will also have to give you more notice when they want to increase the interest rate or credit limit on your card.
"You'll be able to opt out of a rate increase if you can agree a payment plan with your lender," says Quinn. "The card companies have also agreed to contact customers who don't make the minimum repayments and to give them guidance about the risks relating to long-term borrowing on a credit card."
The new rules give credit card holders more protection. However, it's important to pick the right card or cards for your pattern of use. There are five main 'card flexing' strategies for card holders.
REWARD OR CASHBACK?
If, like 61% of credit card holders, you clear your balance each month, the interest rate is immaterial.
"Look instead for a reward card or a cashback card, as you'll get something back for spending on your card," says Michelle Slade, a spokesperson for Moneyfacts.
"There aren't so many cashback cards around now, as many providers prefer to tie customers in with points, but you can still get paid for spending."
But comparing cashback cards isn't always easy. Although some set a single rate for the year, others set a cap on your spend or restrict where you can get cashback. Some cards have tiered cashback returns.
Keeping a balance on a credit card is expensive. With an interest rate of 18.9%, a £2,000 balance will cost you around £30 each month. But it's possible to stem the interest flow with a 0% card.
"More 0% deals have been launching over the last few months, with the 0% period extending even further," says Slade.
Most cards carry a balance transfer fee, typically 2.9% to 3% of the balance you want to transfer, but it's often worth paying this to sidestep the interest charge. Make sure you keep up with the minimum repayments, though, as the 0% APR could be replaced with a much heftier interest rate if you miss one.
If you're likely to have a balance at the end of the term, transfer to another 0% deal, as many 0% cards have high follow-on rates.
However, Hagger warns against taking these deals for granted. "The card companies are being more choosy, and you'll need to have a squeaky clean credit record to qualify," he says. According to the UK Cards Association, 48% of applications are rejected, up from 42% in 2008.
Think about where you might transfer the balance, as there are often restrictions on transferring between cards from the same company.
NEW PURCHASE PERK
Some cards charge 0% for new purchases. These could be particularly suitable if you're planning a major purchase that will take a few months to pay off or if you're expecting a windfall, such as an inheritance, to clear your debt.
"They allow you to defer repayment of the balance, so you need to have financial discipline to take advantage of them. But there are some good offers available," says Hagger.
If checking rates and offers is a bore or you don't fit into one of the categories mentioned, a card with a low standard rate may be the solution for you. If you're unable to clear your balance one month, you won't pay a crippling interest rate.
Travellers of all types should have a card that's a good travelling companion. Spend on a credit card abroad and most card providers will slap on a foreign usage fee.
"On most cards, you'll pay between 2.75% and 2.99% when you use your card abroad," warns Slade. "Most people don't think about it until they see their bill."
But some card providers, including Saga, Halifax, Santander and the Post Office, spare their customers the extra charge.
Many people benefit from having more than one card. You might clear your balance each month on a reward card but keep a card with no foreign usage fee for your travels. Or perhaps you have transferred a balance to a 0% card, but you need another for your regular spending that you'll be able to clear each month.
Whichever card you choose, it's important to understand how it works. "Never use it to withdraw cash," says Paul Lawler, a spokesperson for Moneysupermarket.com.
"The APR for cash withdrawals is usually higher, often around 27% to 30%. And if you do this abroad, many cards will also hit you with a cash fee of between 1.50% and 3%, subject to a minimum charge of up to £3."
You'll also be charged interest from the day you make a cash withdrawal, so even if you clear your balance each month, you'll pay interest.
Be sure to make your minimum repayment each month or you'll be hit with a late payment charge of £12. "Making a monthly repayment on time is important, especially if you're on a 0% deal, as otherwise the rate will revert to the full APR," Lawler explains.
One way to avoid this is to set up a direct debit to make the minimum repayment every month. Given the clampdown on high charges and unfair payment practices, credit card companies are now seeking other ways to make money.
"Rates have risen over the last few years," says Lawler. The average rate on the top 24 cards on moneysupermarket.com has increased from 16.47% at the beginning of 2009 to 17.41% in September 2010.
"Some card companies also restrict who they'll accept," he adds. Monthly and annual fees may also return to the market.
Affinity cards are offered by organisations ranging from charities and football clubs to supermarkets and airlines.
Those offered by organisations such as charities, football clubs and universities enable cardholders to support the organisation, with a percentage of their spend going to the card issuer.
An unexpected one-off financial gain in cash or shares, generally when mutual building societies convert to stock market-quoted banks. Also windfall tax, a one-off tax imposed by government. The UK government applied such a measure in the Budget of July 1997 on the profits of privatised utilities companies.
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%.