Five Things You Didn’t Know About Credit Cards April 24, 2009Posted by ibnmahadi in Uncategorized.
Most people know misusing credit cards can lead to debt disaster. However, even if you’re generally sensible with your credit card, the relationship you have with your flexible friend may not be as simple as it seems.
Lenders love to include tricky terms and conditions in credit agreements, which often muddy the waters of how cards work – and can mean you end up paying far more for the privilege of using your plastic…
1. Negative payment hierarchy
As far as most lenders are concerned, not all forms of debt are the same – even when they sit on the same credit card.
Companies use categories to classify different types of debt. Balance transfer debt, purchases debt and cash withdrawal debts, for instance, are usually listed individually on bills and can attract wildly different rates of interest.
Most lenders put the cheapest form of debt you hold (usually balance transfer debt) at the top of the payment priority list, leaving the most expensive (often cash withdrawal debt) at the bottom. This is called a negative payment hierarchy because, in terms of how much they cost, it means you’re paying back your debts in reverse order.
For example, if you held £2,000 of cheap balance transfer (BT) debt and £500 of expensive cash withdrawal debt (CW) on the same credit card, you would have to pay off your entire BT before you were able to make a dent in your outstanding CW balance.
In the meantime, this ‘untouchable’ CW debt would be racking up hefty interest charges, potentially costing you a significant sum.
This is why, as I explained in my article Recession Busting Balance Transfers, it’s usually a disastrous idea to spend on a balance transfer credit card.
2. Monthly minimum repayments (MMRs)
The MMR is the minimum sum you must pay off your credit card balance each month. However, lenders generally set these so low they barely cover the amount of interest charged on your debt.
Typically, a credit card’s MMR will be either 2% or 3% of the total balance, or £5 (whichever is the greater).
However, some lenders specify even lower MMRs. Cards issued by the Halifax Bank of Scotland (HBOS) group, for example, come with an MMR of just 1%.
Blithely paying back the MMR is a catastrophe for any cardholder who wants to beat down their borrowing. This is because sticking with the small monthly sum most credit card companies demand will not help you diminish your debt – and in fact could mean it lasts for decades.
Here’s a scary example: a person who held a fairly modest credit card balance of £2,000 at a rate of 17%, and who repaid only the MMR of 2% each month, would be saddled with that debt for a staggering 32 years!
It may seem shocking, but it makes perfect mathematical sense. This is because MMRs are generally worked out as percentages – and as your credit card balance decreases, so will the amount you’re regularly required to pay off.
No matter how large your credit card balance, it’s crucial to try and overshoot your lender’s MMR when you’re making repayments. Paying off an affordable fixed sum each month could significantly shorten the lifespan of your credit card debt.
3. Foreign transaction charges
When you’re on holiday, it’s often tempting to pound your plastic. After all, whipping a credit card out of your wallet is far less hassle than queuing to exchange currency.
Sadly, if you use the wrong credit card abroad it’s likely you’ll be stung by a host of horrible charges. Many lenders add foreign currency loading fees (typically around 2.75%) onto transactions made abroad, and also charge high interest rates and fees for cash withdrawals.
If you’re a keen traveller and prefer to use credit cards on holiday, it makes sense to get a credit card specifically for this purpose. The Post Office Platinum MasterCard is a good choice as it will not add a foreign currency loading fee to overseas spending (though you will still be charged for withdrawing cash from an ATM).
4. Interest free periods
An often unsung benefit of credit cards is the interest free period they offer. Usually, any purchases you make won’t start accruing interest for several weeks – and this applies to bog-standard credit cards as well as special promotional deals.
So, what’s the catch? Firstly, some credit card providers offer longer interest free periods than others.
While many lenders allow customers up to 59 days to pay their bills, others offer significantly smaller windows of opportunity. The Lloyds TSB Advance MasterCard, for instance, offers no interest free period at all.
Secondly, the interest period that comes with any credit card only remains interest free if the balance is paid in full and on time.
If you don’t repay what you’ve borrowed within the time your card issuer allows, interest charges will be applied – and back-dated to the days when your purchases were made.
5. Penalty charges
If you use a credit card, it’s crucial to avoid missing payments and ensure you don’t exceed your credit limit. If you do, you’ll be breaking the terms of your credit agreement with the card issuer – and you’ll be liable to penalty charges of £12 for each mistake you make.
Worse still, it’s likely that a missed payment will leave a blemish on your credit history. This could make it harder for you to obtain credit in the future.
Just as importantly, breaking the rules with a balance transfer card might mean you lose your promotional deal. I’ve heard horror stories of 0% offers being withdrawn, even after just one late payment. Don’t let this happen to you!