Avoid the minimum payment credit card trap

Debts will grow in the long term. Chiara Cavaglieri reports
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The Independent Online

This month marks an end to the highly controversial credit card practice known as "negative payment hierarchy" which forced consumers to build up more interest than was necessary on credit cards.

But while the practice has all but been abolished, consumer finance experts say there are even bigger possible pitfalls. Previously, credit card providers would allocate customer repayments towards the lowest interest-accruing debts first, while leaving the higher-interest debts to fester. But while providers may no longer employ this practice, experts warn there is still value to be had from keeping purchases on separate cards.

Hannah-Mercedes Skenfield, a credit card expert at Moneysupermarket.com, says it is still possible to lose. "The new positive payment hierarchy rules allow borrowers to pay off their most expensive transactions first before those on lower promotional rates," she says. "However, it is still possible to be caught out. If you are planning to use a card for balance transfers and purchases you should opt for a card with equal length balance transfers and purchase promotional offers, or use two separate cards. If not, you could find yourself paying off purchases without reducing your outstanding balance transfer balance."

There are other traps to avoid such as using a card to withdraw cash. The cost of using credit cards in cash machines can be prohibitive, with cash withdrawals incurring a fee as well as interest.

David Black, a banking expert at Defaqto, says this type of withdrawal can ramp up consumers' costs considerably. "The average interest rate charged for cash advances is 25.2 per cent and the average fee is 2.71 per cent, although most charge 3 per cent," he says.

Another common mistake comes with using credit cards abroad. Many providers will charge users a loading fee of about 2.75 per cent, exchange rates, cash withdrawal charges and interest on overseas purchases, adding up to a hefty bill. To make matters worse, exchange rates vary.

"Tesco set their own foreign exchange rate to convert their customers' overseas purchases while other companies use the Visa or Mastercard daily rates which are very competitive," says Ms Skenfield.

With many credit cards carrying low-level minimum monthly repayments (MMRs), the onus is on consumers to ensure they not only match but also pay well in excess of this amount. Just sticking to the MMR can have dire consequences.

A £1,500 purchase balance repaid at 3 per cent or £5 per month, with an APR of 16.9 per cent, would cost £1,088.89 in interest over 14 years and six months. But increasing the repayment to £50, reduces the interest incurred to £417.97, taking three years and three months to pay off.

Louise Holmes, a spokeswoman for Moneyfacts,co.uk, says setting a monthly contribution rate personally can pay off. She adds, "Typically, the first debt to default on in times of hardship is credit card debt, so consumers looking for a suitable card should primarily make sure they can make the necessary monthly repayments – not just the minimum amount as this can prolong paying off debt."

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