If you've got credit card debt, should you be worried about the credit crunch?
This article was first sent to Fools as part of our 'Cracking The Credit Crunch' email.
If you've got credit card debt, should you be worried about the credit crunch?
The simple answer is: yes. This is not a good year to be in debt on your credit card. I'll repeat that. This is not a good year to be in debt on your credit card.
Several of our readers have reported that the interest rates on their cards have increased dramatically and a recent survey of Fool readers found that one in eight card holders have had their credit limits cut, with the average spending limit pruned back by around 7%.
And, as Egg customers discovered earlier this year, credit card providers can withdraw their credit cards without warning.
Credit Crunch Starts To Bite
Don't assume that if this happens to you - or if the interest rate on your card suddenly goes sky-high - you'll be able to switch your balance to another card whenever you need to. Getting hold of a new credit card is becoming increasingly more difficult.
More than three million applications for credit cards were rejected in the last half of 2007 (an increase of 20% on the previous six months) and there are far fewer cards around than there used to be.
As the credit crunch escalates, this situation only looks like it's going to get worse.
But don't despair! It's not too late. If you take control of your debt now, you can easily ensure that, by 2009, it is only distant memory, wafting through the mists of time.
Destroy Your Debt
The way I see it, if you are serious about getting rid of your credit card debt this year, you have two options:
1) You could switch your balance to a 0% balance transfer card.
2) You could switch your balance to a lifetime balance transfer card.
0% Balance Transfers
With a 0% balance transfer card, you pay no interest for a set period, ranging from six to 15 months.
During this period, 100% of your payments go towards paying off the outstanding debt you owe.
Since most credit cards typically charge around 16% interest a year, this will help to reduce your debt far more quickly than usual - and save you hundreds of pounds, as this table shows.
Over 15 months:
Interest Rate On Credit Card (APR)
|
Balance
|
Payment per month
|
Total amount outstanding after 15 months
|
Amount paid off
|
|---|
15.9%
|
£1,800
|
£25
|
£1,782
|
£18
|
0%
|
£1,800
|
£25
|
£1,425
|
£375
|
So by transferring a debt of £1,800 to a 0% card, you would save £375 over 15 months.
The best 0% balance transfer available at the moment is the Virgin Money credit card, which offers 0% interest on balance transfer for 15 months - the longest interest-free period of any card on the market. However, bear in mind that you have to pay fee of 2.98% of the balance you are transferring.
And if you don't clear your balance within 15 months, you will again start paying a whopping 16% interest on your debt.
To avoid this, you would have to switch again to another 0% credit card. But in 15 months' time, this may be a lot more difficult, due to the credit crunch.
Lifetime Balance Transfers
That's why I think lifetime balance transfer cards may be a good idea for anyone who has a large amount of debt which, realistically, you do not think you will clear within 15 months.
With a lifetime balance transfer, you pay an extremely low rate of interest on your debt until you have cleared your balance. This means you don't need to apply for a new 0% card every year or so. And you don't need to worry about whether the credit crunch will make it harder for you to get credit in the future.
The best lifetime balance transfer available at the moment, in my opinion, is the Barclaycard Platinum Credit Card at 6% APR, because it doesn't have a balance transfer fee. It's 1% higher than the cheapest card (the Citi Platinum card) but you save that 3% fee so I reckon it's quite good.
Finally, with both lifetime and 0% balance transfer cards, you need to watch out for negative payment hierarchy. Put simply, you will be charged a high rate of interest on new purchases, and you will not be able to pay this extra debt off until you've cleared your existing balance. So the moment you get hold of your new card, my advice is: chop it up!
If you must spend on a card, use your original, existing credit card instead and set up a direct debit to pay that card off in full every month. That way, you will stay on top of your spending and ensure you are paying off your debt, instead of simply moving it around.
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