FOOL SCHOOL
How Credit Cards Work

July 25, 2005

Credit cards are the power behind the purses and wallets of about two-thirds of UK adults, which means that over 30 million of us are carrying one or more around! Roughly half of us have only one card, but a sizeable minority have five or more plastic friends. Yikes!

There are roughly seventy million credit cards in issue in the UK, on which we spend about £10 billion a month. What's more, our cards should be red-hot, because we use them about two billion times a year.

We're also borrowing a lot more on credit cards these days. In fact, over the last ten years, our credit card debt has more than quadrupled. So, we Brits have become "plastic junkies", using our credit cards to borrow routinely, as well as to spend. Oops!

Of course, used wisely, credit cards are a convenient tool to help with everyday budgeting. If you pay off your bill every month, you can enjoy up to 59 days' interest-free credit. However, only around half of cardholders do this, with the remainder ending up paying interest. Credit cards are a horribly expensive way to borrow money and, used carelessly, they can cripple your finances and leave you with a long-term debt problem. Yikes!

Then again, paying by credit card can be better than paying by cash, cheque or debit card. That's because you have extra legal protection if you use your credit card to buy anything costing between £100 and £30,000. Under Section 75 of the Consumer Credit Act, your card issuer is said to "wear the supplier's shoes". Hence, if goods don't turn up or prove to be faulty, or if the supplier misleads you, breaches the contract or goes bust, you can seek compensation from your credit-card issuer.

This 'joint liability' is especially useful when suppliers go out of business, as occasionally happens with, say, travel firms. However, Section 75 does not apply to debit or charge cards and some card issuers will not consider claims for foreign purchases.

0% Cards

The world of credit cards has changed enormously in recent years. In the Nineties, annual interest rates of 20%+ APR were the norm. However, the battle for new customers and the arrival of several aggressive new entrants has changed the market for the better. These days, you can find cards charging standard interest rates of under 10% APR, but the biggest growth has been in so-called "0% cards".

The first 0% card arrived in Christmas 2000, when online bank Egg started charging no interest on debts transferred to new Egg cards for a limited period. Other lenders jumped on this bandwagon and now around a hundred different "0% on balance transfers" cards are available. Most have a "zero interest" period of five or six months, but the Best Buys and market-leading offers extend this period to nine months or even a year.

Given that the average balance per cardholder is roughly £1,500, there are substantial savings to be made from switching debt from a card charging, say, 18% APR to a 0% card. Therefore, if your credit rating is up to scratch, switching expensive debts to a 0% card should be a straightforward exercise. Some card firms will ask you to list your balance transfers on your application form, while others allow you to provide this information further down the line, either online or by telephone.

Know Your Cards

How well do you know your plastic? Do you know the differences between debit and credit cards? Many people don't, so here's the low-down on the differences between the various types of plastic:

• Debit card transactions are automatically taken from your bank account within a few days of your purchases. Think of it as an 'electronic cheque'. No form of 'credit' is involved.
• Credit card - you receive a monthly statement and it's up to you to decide how much to pay off each month, subject to paying the stipulated minimum monthly repayment (as little as 2% of your balance!). An 'affinity card' is a branded credit card that is linked to a particular organisation, such as a charity or sports team.
• Charge card - you receive a monthly statement, which you have to pay off in full each month. American Express and Diners Card are the most well-known examples.
• Charity card - a credit card that makes a donation to charity when you open an account, plus a small percentage of your spending is donated to charity.
• Store card - the Devil's debt! They are frighteningly easy to get, but charge sky-high rates of interest - most charge between 25% and 30% a year. Avoid at all costs, unless you are certain that you will pay them off in full each month. Only useful for initial discounts and to scrape your car windscreen on snowy days!

> Find your perfect plastic in our Credit Card centre!