FOOL'S EYE VIEW
Credit Card Tricks Exposed!

By Cliff D'Arcy
October 23, 2003

Before joining the Fool, I had a fifteen-year career in banking and insurance ('career' is perhaps too sensible a description, although it certainly careered all over the place!). Working in marketing, I spent a lot of my time trying to con trusting punters into buying over-priced products. Another of my responsibilities was market research and intelligence: analysing the financial services market, its players and products.

After a lengthy stretch, I finally made parole and decided to make amends by using my inside knowledge to help the public to avoid poor financial products and uncover the best deals. However, far too often, there are too many of the former and too few of the latter!

For example, earlier this year, I warned readers to look out for these banking tricks. I had some enjoyable feedback on this article, so here are five credit card swindles to watch out for:

1. A debt that lasts longer than a mortgage

A typical credit card charges interest at 1.5% a month plus, say, 0.7% for repayment protection (see below). You repay a minimum of 3% a month (at least £5 or the entire balance). So, how long does it take to pay off a typical debt of £1,600?

Five years? Ten? Fifteen? Think again: it takes twenty-eight years and seven months (343 months). So, start at twenty-one and you could pay off your card debt just before your fiftieth birthday!

Don't believe me? Then learn more about Nasty Cards and Nice Cards.

2. Rip-off card protection

Credit card repayment protection is one of the most ridiculously over-priced products ever. It's an insurance policy that meets your monthly repayments if you can't work because of accident, sickness or unemployment. Also, it pays off your balance if you die. Learn more here.

Sounds good? Well, it isn't, because it's unbelievably expensive. Back in the Eighties, most policies would pay 10% of your outstanding balance for every month you were not working. However, in the Nineties, many policies switched to paying only minimum monthly repayments. In effect, this change has more than tripled the cost of this cover, because most policies now pay 3% a month, not 10%! Here's an example, comparing two different policies:

Card issuer   Cost per £100   Monthly benefit   Cost of £100 of 
                  per month                     monthly benefit
MBNA                72p              3%             £24.00
Egg                 74p             10%              £7.40

So, to the unwary, Egg's policy looks more expensive (0.74% of your balance per month, versus 0.72% for MBNA). However, because Egg's policy is far more generous when it pays out, MBNA's cover is effectively over three times as expensive. I'd go as far as to say that MBNA's policy stinks – I certainly wouldn't touch it with the proverbial bargepole!

What's more, in recent years, lenders have been hiking the cost of this cover, knowing that we won't notice or care. After all, do you read all the guff in the small print on your statements and all the other junk in the same envelope?

Let me put this as simply as I can: this cover typically costs between five and twenty times as much as it should. If I discovered that I was unwittingly paying for one of these absurdly over-priced policies, I'd cancel it today. As it is, I've never bought one in my life - and never will!

3. Different interest calculations

You'd think that the interest rate – the Annual Percentage Rate, or APR - used by card issuers would be calculated using a standard formula, wouldn't you? Well, you're both right and wrong. Here's why:

Note that interest at 1.5% per month doesn't equal an APR of 12 x 1.5 = 18%. This is because of the effect of compounding (interest being charged on interest). In fact, the calculation of the APR - ignoring annual fees, which most lenders don't charge - is:

(1+monthly interest rate) ^ 12 minus 1

where ^ means 'to the power of' – i.e. multiplied by itself twelve times in this case.

So, 1.5% a month = 1.015 ^ 12 – 1 = 19.56% APR (thanks to interest alone, your debt keeps doubling every four years at this interest rate - ouch!)

So, here's the APR snag: if you don't pay off your bill in full, different lenders will charge you interest from different dates. Here's an example:

A. You buy an item in the sales on 1 January
B. This appears on your statement on 4 January
C. Your statement date is 31 January
D. Your payment due date is 25 February
E. You don't pay off your entire bill by 25 February and therefore pay interest.

A few lenders charge interest from point C, but most charge interest from point A or B. So, despite displaying the same APR as their rivals, C-type cards will charge you less interest than A and B cards. Bonkers!

4. Credit cards and Direct Debit

On the whole, I'm a fan of Direct Debit (DD), as it allows us to earn discounts for prompt payment and avoid inflated late payment charges. I pay all the usual bills by DD: mortgage, water, gas, electricity and so on.

I also pay my credit card bills by DD, but two things annoy me about this. First, most lenders will collect monthly repayments well before final 'payment due dates', which deprives us of our money earlier. Second, almost all credit card issuers only allow us to make minimum repayments by DD, which means that we can't use DD to pay off the entire bill every month.

The reason for this is obvious: lenders make a fortune from cardholders who don't repay their bills in full, so why make it easy for us to pay off our entire debt every month? I think the proposed new consumer credit rules should force lenders to give us this option, making life far easier for millions of sensible borrowers.

5. Sneaky shifting of payment dates

Over the years, I've had credit cards with almost every major issuer. One thing I've always suspected is that several lenders appear to manipulate payment dates to their advantage.

For example, it's amazing how frequently my 'payment due date' falls on a Saturday or Sunday – far more often than is likely through random chance alone. Because my payment has to reach the lender by the previous Friday, it gets my money earlier and so improves its cash flow. It's hard to prove, but I suspect that some lenders subtly shift our statement dates in order to hit weekends and thus bring forward our payments by a couple of days.

More: Credit Card Centre | Weapons Of Money Destruction! | Britain's Most Expensive Credit Cards | Turn Nasty Cards Into Nice Cards! | Cunning Credit Card Conduct.