The credit card you'll never pay off

by Neil Faulkner on 28 August 2009  |  10 comments
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There are some very sinister tricks that lenders use on us. This is one of the worst...

One of the most obvious ways that credit-card companies make money is by charging us interest when our introductory deals expire.

It's far from the only way. Lenders make even more money through more than a dozen different tricks that trap us into paying interest, charges or other costs without understanding why.

I'm not writing about those tricks today though. Today I'm looking just at the cost to you of sticking with your credit card when introductory deals expire, which is probably more than you think.

How costly is the minimum payment?

When your deal expires, the interest rate shoots up to, on average, 18.1% APR (which is variable).

There's no question that that is an extremely expensive debt. With plenty of credit cards offering 0% deals (albeit it with 3% fees) and with unsecured loans at less than 8%, the standard credit-card rate is very, very high.

These high rates of 16% to 22% APR are not the end of the matter.

The worst bit is that the minimum payment you're obliged to make is dreadfully small. Typically now you're obliged to pay just 2.25% of your debt each month. I had a quick look at some of the cards with the longest deals. (There are currently a couple of dozen or so offering 12 month deals or more on balance transfers.)

You may be confused about the 18.6% APR I've quoted for Virgin, because it advertises 16.6% as typical. The reason is that the 16.6% rate applies just to purchases and the 18.6% rate is for balance transfers. Sneaky.

Most of these take 2.25% as a minimum repayment, until your balance gets to around £5, when it clears the lot.

About one-third of applicants who are accepted for these cards are expected to be offered worse interest rates, which seems to me to be normally about 5% more than the 'typical' rate.

Let's assume your rate is 17.9% APR and you pay just 2.25% of your debt off each month. On a debt of £5,000, after one year you'll have paid about £790 in interest, but reduced your debt by around £510. That's almost £300 more interest paid than debt cleared!

It's worse if you take out the unbelievably over-priced payment protection insurance (Don't do it! You can buy it from independent insurers for 1/10th of the price, or consider alternatives.)

Many card lenders will end up reducing your debt by just £5 per month after you pay the interest and insurance premiums. Your debt will come down just £60 after one year and yet you'll pay even more interest.

Set your own minimum repayment

If you'd set your own minimum repayment the story would be much happier. If you have a £5,000 debt it would make sense to pay at least £200 per month. This works out at about 4% to start with, but as your debt goes down, £200 becomes a higher percentage very rapidly, meaning you clear your debt faster and faster.

Conversely, if you stick to the minimum repayment, you will clear your debt slower and slower!

At £200 a month, in the first year you'll pay just £700 in interest and reduce your debt by £1,700. Now that's much more like it. What's more, in the following two years you'll clear your debt even faster and pay even less interest, whereas someone who had just been paying the minimum will not reduce the debt or the interest payments much at all.

The card you'll never pay off

Sometimes some lenders bring back this disgusting trick - a debt that goes up, not down, when you make just the minimum repayments! At the moment it's Virgin's turn to use this terrible technique.

You'll notice in my table that Virgin's typical APR is 18.6% and it's monthly interest, therefore, is 1.44%. You'll also see that it's minimum monthly payment is just 1%. This means that you're paying less each month than the total interest you're charged. It'd be even worse if you got a higher than typical APR!

It gets worse.

The minimum payment is taken from your debt but excludes the interest you've paid that month.. If it included the interest, which is normal, then your 1% payment would be larger, meaning you'd contain your debt better. By deducting the minimum in this more devious way, it takes even longer to clear your debt and you pay even more interest as a result.

What would happen if you paid the minimum on a Virgin card with a £5,000 debt? After one year you'll have paid more than £600, yet your debt will have risen by more than £250!

The Virgin Card has the longest balance transfer deal on the market at 16 months, so it's the best one to go for if you have a large debt. But be wary of the tricks and don't leave your debt on this card after the introductory period has expired.

If you can't get a new 0% card or a significantly cheaper loan, or if your debts bother your thoughts sometimes, you should get quality, free advice from National Debtline or The Motley Fool's Dealing with Debt board. (People from Northern Ireland could try Debtline NI.) It can't hurt to get free ideas from impartial sources. Also check out our Get out of debt section.

More: Buy now, pay later at no extra cost! | 12 ways your credit card rips you off!

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