Don’t be caught out by this sneaky credit card trick
Credit cards are one of the most popular financial products, yet widespread confusion about payment structures is putting thousands of people at risk of financial loss.
New research shows that more than two-thirds of consumers are still unaware that, in the vast majority of cases, using just one credit card for spending and to clear debts does not make financial sense.
This is because most credit card providers use a payment structure known as negative payment hierarchy to clear debts from your card. Simply put, while you might consider your credit card debt as one lump sum, your provider won’t. So, your balance transfer debt will be considered as separate to your purchase debt or cash withdrawals.
This means that when you make payments, your money will not be used to pay off the debt as a whole. Instead, your provider will use your payments to clear the cheapest balances first – otherwise known as negative payment hierarchy.
Why does this matter? Well, imagine you have a credit card with a £1,000 balance bought over from a previous credit card and a £500 balance of new purchases. The balance transfer element of your debt is currently interest-free, whereas you are being charged 17% APR on your purchases debt.
Let’s say you make a payment of £500. While you might assume this will clear your purchase debt, leaving you able to pay off your balance transfer without attracting any interest, this is not the case.
With a negative payment hierarchy credit card, you will need to make two months’ payments of £500 before your balance transfer is paid off. In the meanwhile, your £500 purchase balance is attracting interest of 17%.
Despite the fact that nearly every credit card provider uses negative payment hierarchy, research from moneysupermarket.com shows that just 34% of consumers expect providers to pay off their cheapest debt first.
The government is now looking at forcing card providers to use payments to pay off the most expensive - rather than the cheapest - debt first. However, such a move is some way off.
Read more on the proposals
Currently, the only two providers not of use negative payment hierarchy are Nationwide and Saga.
Nationwide claims its credit card’s payment structure could save the average customer £224 in the first year, assuming a balance transfer of £2,020, £307 of new purchases each month, £84 withdrawn in cash in the first and seventh months and monthly repayments of £359.
This is because it uses positive payment hierarchy, with your repayments used to pay off the debts attracting the highest rate of interest first.
Nationwide's Gold Credit Card offers 0% interest on balance transfers for 13 months (subject to a 3% fee of at least £5) and 0% on purchases for three months. The typical APR is 16.9%, although you do have 56 days to pay off purchases before interest is charged.
The Saga Platinum Credit Card, meanwhile, offers 0% interest on purchases and balance transfers for the first nine months, subject to a 3% balance transfer fee. After this time the typical APR is 11.9%, although you have 55 days to clear your purchase balance before interest is charged.
Unless you opt for one of these two providers offering positive payment hierarchy, it's well worth considering using one credit card to clear your balance transfer and another to make new purchases.
If you are confident you will be able to pay off your balance within a reasonable time period, then a 0% balance transfer card is probably your best bet. Just bear in mind that you will need a good credit history in order to qualify for this type of card. In addition, a fee to transfer your balance will applie - this is normally around 3%.
The most generous 0% balance transfer period is currently 16 months (see below). If you require longer to pay off your balance, then it might make better financial sense to opt for a credit card with no introductory period but a long-term low rate of interest.
In terms of making new purchases, there are plenty of cards out there that offer up to 10 months' interest-free. These are great if you need to make a big purchase but can't afford to pay for it in one go. However, if you want a longer term credit card for purchases then you could also opt for a low-rate cashback card or simply make sure you pay off your balance in full within the interest-free period.
How positive payment hierarchy cards compare:
(3% fee or £5)
|3 months||16.9%||56 days|
|9 months||11.9%||55 days|
|3 months||16.6%||50 days|
|3 months||16.9%||59 days|
|9 months||15.9%||59 days|
|Marks & Spencer Money||6 months||10 months||15.9%||55 days|
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%.
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