If you're going to use credit cards wisely, you need to understand how interest and other charges work.
When Barclaycard was launched in 1966, it was the UK's only credit card. How times have changed: 37 years on, there are something like 1,500 differently branded credit cards in the UK, which is hardly surprising when you consider
our current appetite for debt. Nevertheless, Barclaycard remains far and away the UK's most popular card, with around 8.4 million customers.
Fierce competition among card issuers has created an intensely fragmented market, with cards to suit all classes, from the super-rich to those with poor credit histories. In order to attract increasing numbers of cardholders, card issuers have relaxed their credit-scoring guidelines and come up with several fiddles to whisk more money from our pockets.
Here's an example of how unbelievably different two cards can be when it comes to borrowing money (for those naughty, naughty borrowers who don't pay off their bills in full every month!):
'The Nasty Card'
Here are the terms of the Nasty Card:
- Your minimum monthly repayment is 3% of your monthly balance, minimum £5
- We charge you interest at a monthly rate of 1.5% (19.6% APR)
- We charge you 70p per £100 owed per month (that's another 0.7% a month) for payment protection insurance (PPI).
So, you're repaying 3% a month and being charged 2.2% a month (1.5%+0.7%), so you're repaying a net 0.8% a month. Thus, it will take roughly 1/0.8% = 125 months to clear your debt, right?
Wrong! Your monthly repayments are calculated on the reducing balance, not on your original £1,600. They start at £48 and drop steadily until you make your final repayment of £1.63. That's why the typical Nasty Card debt of £1,600 will take you, wait for it...
28 years and seven months (343 months) to repay!!!
So, start on your 21st birthday, and you could be debt-free before you celebrate your 50th, having paid Nasty Card a total of £5,679 along the way (that's your original £1,600, plus an unbelievable £2,781 in interest and £1,298 in PPI premiums)!
'The Nice Card'
Here are the (slightly stricter) terms of the Nice Card:
- Your minimum monthly repayment is 5% of your initial monthly balance (£80, using the above example)
- We charge you interest at a monthly rate of 1.5% (19.6% APR)
- You are not covered by our PPI policy
- You cannot spend on your card until your current debt is repaid in full.
Note that the interest rate is the same as the Nasty Card's, but your monthly repayment is fixed at a flat 5% of your initial debt, and you've stopped paying for over-priced insurance. Crunching the numbers tells us that we would repay our £1,600 debt in just...
Two years (24 months)!!!
Note that your interest bill is a mere £317 and you repay £1,917 in total. The downside to the Nice Card is your repayments are fixed at a slightly higher level and you don't enjoy the 'benefit' of rip-off card insurance, but you clear your debt 26.5 years earlier, which is worth doing, wouldn't you agree? Sadly, almost all our cards are Nasty Cards - I know of no card that meets the Nice Card conditions.
The good news is you can create your own Nice Card today. All you need to do is set up a standing order (for 5% of your original balance) to your Nasty Card on your payday (check that this fits with the 'payment due' dates on your card). The hard part comes next: cut up your Nasty Card and stop using it. Then, in two years, you'll be debt-free and perhaps able to pay your bill in full every time. So, what are you waiting for? Bring forward your 'debt-free day' by 26.5 years today!
More: Win £2,500 off your credit card! | Get Out Of Debt Centre | Dealing With Debt discussion board.
