Beware Of This Dirty Credit Card Trick!

by Szu Ping Chan on 23 December 2008  |  9 comments
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As Christmas approaches, we reveal how one sneaky credit card trick could leave you out of pocket by over £300...

With Christmas finally at our doorsteps, many of us will finally be relaxing in the knowledge that all the preparation and present buying is over for another year.

But amid all the gifts and gatherings, some of us will also be relying on our flexible friends to help us get through the festive period.

According to recent research by Abbey, while 20% of us will fund our festive cheer by dipping into our savings, over a fifth (21%) will pay for our Christmas shopping entirely on credit cards.

Here at The Fool we’re always suggesting ways to ease the burden of debt. But 0% credit cards and better budgeting tips can only go so far, and there are some sneaky charges imposed by credit card companies you won't even be aware of.

For example, according to over-50s specialist Saga, shoppers could save over £300 by switching to a credit card which avoids something called negative payment hierarchy.

Credit by hierarchy

But what is negative payment hierarchy? Well, let’s say I make a 0% balance transfer of £1000 to my credit card, then make a purchase of £500, for which I am charged 18.9% APR. I then decide to pay £500 towards my card.

A card that operates negative payment hierarchy allocates this payment to the promotional balance transfer, and not my purchase, which continues to rack-up lots of interest.

In short, cards which operate negative payment hierarchy pay off the cheapest debts first, such as promotional balance transfers, and the most expensive, such as cash advances, last.

We’ve written several articles about negative payment hierarchy in the past, and personally, I think it’s one of the sneakiest tricks in the credit card book.

Most big name providers including Barclaycard, Capital One, Egg and Mint employ this trick, with only two providers to my knowledge, Nationwide and Saga, doing the opposite and allocating payments to the most expensive debts first.

But just how much could a card that operates negative payment hierarchy end up costing you?

Saga calculates that a customer making:

• a one-off balance transfer of £2,000 at 0%
• plus £1,000 in monthly spend at 15.9%
• and £350 a month in cash withdrawals at 23.9%

over the course of one year would pay £343.54 more in interest over the time it takes to pay off the balance (assuming they made an £850 a month payment) than someone with exactly the same spending habits, attracting the exact same interest rates on their balances, but using a card which operates positive payment hierarchy.

All because of the way the payments are allocated.

Obviously the example used by Saga is an exaggerated, and some would argue, unrealistic one, and I for one would never advise anyone to take money out on their credit card.

However, it does illustrate that while we all-too-often look at balance transfer and cashback deals, what seems like a small technicality can end up costing hundreds of pounds in unnecessary interest.

Fighting the negative trap

So what can you do to fight this payment hierarchy trap? The first is to pay off your credit card balance in full each month. That way, negative payment hierarchy will never affect you.

If this is more of a dream than reality, you should also be wary of cards with uneven promotional periods, such as those that offer 0% for 12 months on balance transfers, but only 0% for three months on purchases.

These cards are particularly guilty of negative payment hierarchy, as once the promotional purchase period ends, any purchases you’ve made will start to accrue interest at the lender’s standard rate.

One notable exception comes in the form of the Virgin Money Credit Card. Not only is it the current market leader in terms of balance transfers, offering 16 months interest-free on all transfers made (a 2.98% fee applies), but you also get six months interest-free on purchases.

However, as Laura Starkey highlights, unlike the majority of cards which lure you in with enticing promotional periods with a sting in the tail, the Virgin Money card operates positive payment hierarchy during the promotional purchase period.

This nifty little feature means as long as you pay off any purchases made within the first six months, you can spend to your heart’s content during this period without worrying about a huge interest bill at the end of it.

Just make sure you pay off every penny of your purchases before the six months is up, or you will be charged the standard rate of interest (currently 16.6% APR) once this time has elapsed.

Alternatively, choose a credit card which offers the same 0% period for purchases as it does for balance transfers. As both promotional periods are equal, you won’t run the risk of falling foul of negative payment hierarchy.

That way, while the kids are opening their presents, and the adults are enjoying some well deserved tipple, your credit card will be helping to put some extra cash in your pocket, and not the other way around.