Money Insider: Credit card battle fought on two fronts

Retail spending has become subdued in the current tough economic climate, but that hasn't stopped credit card companies from falling over each other as they try to persuade us to sign up for their new offerings.

During 2011 the battle for new card business has tended to focus on extended interest-free balance transfer deals, however recently we have seen more cards offering rewards or cashback.

In the balance transfer market Barclaycard raised the bar to a record level earlier in the summer with a staggering 24-month interest-free deal and along with Halifax it still offers the joint longest term of 22 months, although the Halifax card imposes a maximum transfer limit of £3,000.

Many other cards are offering 0 per cent for 16 months plus, which is evidence that the balance transfer model still works for lenders. They receive a 2.5 per cent to 3 per cent transfer fee up front, and then hope that customers fall into the trap of using the card for their day-to-day purchases too which immediately triggers a new stream of interest revenue.

Prior to the balance transfer craze, credit cards were viewed purely as a tool to help people manage their finances, particularly if they had unexpected expenses that they needed to cover prior to pay day.

A promotional balance transfer arrangement from your card company is simply a loan, and as such there is absolutely no need for you to have a card. But from the providers prospective they want you to carry the plastic around with you, and their pricing models have factored in that a certain number of customers will at some stage start to use their card for new spending.

Making purchases on your balance transfer card is a huge financial mistake and plays straight into the hands of the providers.

They know that customers who make purchases with their card will be liable for interest charges unless they repay their credit card bill (including balance transfer sum) in full – either way it's a win-win situation for the lender, but for the customer, it defeats the object of applying for the card in the first place.

If you are going to opt for a promotional balance transfer card, be smart and don't ruin the benefits of being able to borrow cheaply because of a lack of discipline.

Cut the card up when it arrives, divide the balance transferred by the number of free months and set up a direct debit to pay this amount every month. That way you'll only end up paying a relatively small one-off fee and will be able to make a significant improvement to your overall financial position.

If you need a card to help with your cash flow, then by all means carry a separate card but always aim to repay the monthly statement balance in full if at all possible.

Long-term balance transfer offers are only suited to a limited and probably a dwindling number of customers, which may be the reason that some providers are now paying greater attention to cards that come with cashback or rewards.

One of the most high profile launches comes courtesy of Santander with its new 123 Cashback Credit Card which is being launched on Monday 5 September. The card comes with a £24 annual fee, however for a regular user of plastic, it can still deliver a reasonable return. The cashback is paid monthly at a rate of 3 per cent on fuel spending (maximum £300 per month), 2 per cent on department store spend and 1 per cent on supermarket purchases.

Customers will need to weigh up the potential returns based upon their own spending pattern, however a £500 monthly supermarket bill and a £200 monthly fuel spend will generate £11 of cashback per month or a net £9 once you factor in the cost of the annual fee. The interest rate on the card is 18.9 per cent and as with all rewards based cards, if you don't pay the entire balance every month, the interest charges can easily wipe out any benefits earned.

As well as the recent launch of the AA Rewards Plus card I mentioned a couple of weeks ago, we have also seen a revamp of the Platinum Cashback card from American Express. The 5 per cent rebate on spend in the first three months has been cut to 2.5 per cent (still maximum £100) and now it comes with an annual fee of £25. On the plus side the representative APR has been reduced to 18.5 per cent and the card now plays a flat reward rate of 1.25 per cent on all spend.

It's still possible to benefit from these deals if you use your plastic wisely, but only for those with an excellent credit rating.

Andrew Hagger is an analyst at Moneynet.co.uk