Credit Card Pitfalls - How To Avoid Them!
Credit card companies have many different ways of squeezing a little extra cash out of your wallets. Sometimes the amounts are quite small, but after several years the cumulative effect of all these tricks can cost you a sizable sum.
The minimum monthly payment trick
Many people look upon the low minimum monthly repayment you can make on a credit card as a blessing. In fact, it’s just the opposite. The minimum you can pay has become steadily lower in recent years and now the higher of 2% of your outstanding balance or £5 is fairly typical for a minimum monthly repayment.
Now 2% a month doesn’t sound too bad. Over the course of a year this should mean you pay off almost a quarter of your original debt. The problem though is the high rate of interest that credit cards charge. If you’re being charged 20% interest a year, payments of 2% a month are only going to make a small dent in your debts over the course of a year.
Indeed, paying the minimum amount on a credit card can result in a debt that lasts far, far longer than the typical mortgage – and that’s 25 years. An example will help demonstrate this. Say you have a £3,000 balance with interest charged at 20%. If you pay the minimum of 2% or £5 this debt will be cleared in …… wait for it …… just over 52 years! So if you take out this credit card at 18 you’ll still be paying it off on your 70th birthday. You’ll also be charged over £9,000 in interest over this time, which is over three times the original debt in interest alone
Paying the minimum amount is fine when you have a 0% balance transfer or purchase deal. But with a normal credit card, it’s a life-long debt sentence. If you have more than one card, then pay as much as possible on the one with the highest interest rate and the minimum (or as much as you can afford) on the others. Continue doing this until the first cards is paid off and then repeat the process with the second card and so on. This way you can escape the curse of the minimum monthly repayment!
Card protection insurance
In contrast to our first pitfall, this one is relatively minor. Well, you probably need a breather after that shock.
Card protection insurance provides an emergency service should your credit cards get stolen or lost. They’ll ring up all your card providers, organise replacements and ensure you don’t lose any money as a result. It’s usually offered by one of two main providers – Sentinel or CCP. Sentinel is the largest player in the market, covering some 6 million people.
The cost of these policies is around £20 to £30 a year, so it’s hardly an enormous sum. But you covered for fraudulent losses over £50 and, in practice, banks usually waive this amount anyway. This cover often covers other people in your household too, so compared to some other forms of insurance, it’s not the worst value cover out there. Still, it’s not good value either and many people would rather have the extra £30 in their wallet.
Credit card repayment protection
Let’s turn to another form of insurance. Credit card repayment protection (CCRP for short) is a form of payment protection insurance designed to cover your card payments if you’re unable to pay them due to an accident, an illness or unemployment.
There are a couple of tricks to watch out for here. Firstly, it’s the way the cost is expressed – normally at between 70p and 80p per £100 of cover. Put this way it doesn’t sound like much. But this is for each month, meaning that to protect a balance of £3,000 can cost you almost £300 a year
The second aspect to look at is how much the policy will actually pay each month if you need it. Most policies pay somewhere between 3% and 10% a month, yet still cost around the same per £100 of cover. So a policy that pays out 3% will cost you almost £300 a year yet only pay out a maximum of around £1,000 over twelve months. Obviously those that cover 10% offer the ‘best’ value but it’s still a hefty price to pay for protection that you’ll rarely use.
So, regardless of how much your CCRP policy pays each month, this is one form of optional insurance you can well do without. If you’re worried about protecting your income, a more general form of income protection policy that protects all your outgoings, not just your credit card repayments, will offer far better value for money.
Cash withdrawals
Last of our four pitfalls is withdrawing cash on your credit card. This hits you in so many ways it’s hard to know where to start.
First up, the interest rate you get charged on cash withdrawals is usually higher than for normal purchases. It’s often in the region of 25% to 30% a year. Secondly, you don’t get the normal 45-day grace period you get with purchases, where you pay off your balance a month and a half later and don’t get charged interest. With cash withdrawals the interest starts racking up straight away
Thirdly, you’ll also get hit with a one-off fee for each cash withdrawal. This is typically around 2.5% of the amount withdrawn with a minimum of £2.50. If your withdrawal is in a foreign currency, you‘ll get hit for an additional charge of around 2.5% on top of that. Last of all, due to the way credit card companies allocate your payments, any cash withdrawals you make will be paid off last, as debts with the lowest interest rate are paid off first.
All in all, you’d be better off using a loan shark than withdrawing cash using your credit card. Don’t do it!
