Credit card providers charge interest on balances, but there are ways of avoiding this interest if we pay on time - and ways we might incur more charges.
Equally, some common terms in credit card agreements such as the detail around 0% purchase promotional deals can be confusing.
Whenever we look at a credit card, we should ask what it will cost us and what the penalties are for failing to meet our obligations.
1. Annual percentage rate (APR)
The annual percentage rate or APR is one of the most important things to pay attention to when searching for a new credit card.
An APR tells us what the total cost of borrowing is on that credit card over a year. It includes fees and charges.
However, there's one vital thing to remember when looking at an APR on a credit card comparison page: the representative APR only has to be available to 51% of customers.
This rule is enshrined in the Consumer Credit Act and came into UK law as part of the Consumer Credit Directive, but what it means is that we should always check the APR we're being quoted rather than the representative one used in advertising.
Bear in mind that credit card providers can reassess the risk profile of credit card customers and increase the interest rate accordingly. Customers also have the right to reject such increases - although this does mean paying off the full balance on the card.
2. Credit limit
Credit card providers will set a credit limit when customers take out the card. This is the maximum amount of money a customer can borrow at any one time on their credit card.
This limit protects the borrower from taking on more credit than they can afford. Equally, it protects the lender from giving a customer more credit than they can comfortably repay.
Credit limits are based on a range of factors including:
- Earnings
- Debts such as mortgages, loans etc
- Current credit on other cards, overdrafts etc
- Repayment history on other debts
A credit limit isn't necessarily static, and if we can show that we can repay money on our card and keep up with our other responsibilities too, it's possible the credit card will offer to extend the limit.
Credit limits will be displayed prominently on the credit agreement and on any online/mobile credit account the customer uses to check and pay their balance.
If a customer tries to make a card transaction that goes beyond their credit card limit, it is likely to be declined. If it goes through, customers will usually be charged a fee and the transaction could affect their credit rating.
3. 0% purchase promotions
Credit card providers often tempt new customers with a 0% interest rate on purchases.
This means that the cardholder can make a purchase and will not have to pay interest on the debt for a set period. If the debt is cleared before the interest free period ends, no interest will be charged at all.
0% promotional deals on purchases are ideal for customers who know they can afford to clear the debt within the promotional period
After the deal comes to an end, the interest rate on the card reverts to a higher one, and this can often be a big leap for customers to contend with.
Bear in mind that a 0% purchase period is a promotional offer and the lender can withdraw it at any time if customers breach the conditions of the card.
This could happen if:
- Customers fail to make at least the minimum repayment on their credit balance at the end of every statement period
- Cardholders exceed (or try to exceed) their credit limit
That's one key thing to remember about 0% purchase deals: while no interest is accrued for the 0% deal, customers will still be expected to make minimum payments and so 0% isn't a way of simply piling up purchases and dealing with them all just before the 0% period ends.
It's also worth reiterating that the 0% purchase deal is only on purchases - it isn't applicable to cash withdrawals or other transactions.
What happens when a 0% purchase deal ends?
If the whole balance is paid off during the 0% period, no interest will be charged at all.
After this time, purchases will start to incur interest at the standard rate if they haven't been paid off (or the credit card terms have been breached).
It makes sense to pay off as much of the balance as possible during the interest free period to limit liabilities later on.
4. Cash withdrawals
The general rule is to keep away from withdrawing cash using a credit card.
Cash withdrawals are usually charged at a more expensive rate than purchases on credit cards, with typical charges including:
- Daily interest on the amount withdrawn until the date the balance is paid off
- A cash advance fee that is generally a percentage of the amount withdrawn or a fixed fee, sometimes depending on which would be higher
So, if a credit card provider charged 3% or £15, a withdrawal of 100% would cost £15 while a withdrawal of £600 would cost £18.
As these figures suggest, the costs can soon mount up if we make multiple cash withdrawals on a credit in a month.
Some credit card providers will cap the amount that can be advanced in cash, usually up to around 90% of the maximum limit.
Bear in mind that some transactions are considered to be cash advances by credit card companies when we would not usually categorise them in that way such as:
- Cash back at a till
- Paying a utility bill
- Making a payment on a mortgage
- Buying gift vouchers
- Buying travel money
One further point: cash withdrawals on credit cards are noted on credit records for up to six years. While this may not affect a customer's credit score, it can then be viewed alongside the rest of a customer's credit history and may impact how they view credit applications in the future.
We've come a long way since Barclaycard were encouraging customers to withdraw cash on their credit cards in 2008, and most people avoid this situation wherever possible.
5. Money transfers
Money transfers are often put into a category alongside cash advances, but they work in a slightly different way and there are credit cards on the market that specialise in money transfers.
A money transfer is a transaction that takes money from a credit card into a customer's current account. That money can then be used to pay bills or make cash withdrawals from the current account without having the credit card as a middleman.
This has its benefits but there are also some drawbacks to consider:
- Any purchases made will not be covered by the section 75 protection that covers credit card purchases over £100 (although chargeback may still be an option)
- There are minimum and maximum limits for money transfers, usually £10 and up to 93% respectively
- Money transfers can't be cancelled and fees will not be returned
While money transfers can serve a short-term purpose, the fees they charge will usually be as prohibitive as the cash advance fees noted above - good in an emergency, perhaps, but not useful for everyday spending.
6. Interest free period
The interest free period on a credit card is the time a customer is allowed to pay for their spending before it starts to accrue interest.
This is usually up to 56 days, but the actual interest free period depends where a customer is up to in their billing cycle. For example, a purchase made on the 30th day of the billing cycle would only receive 26 days interest-free.
Not all credit cards have up to 56 days' interest free, with some cards providing 45-day interest free periods instead.
For customers who intend to use their credit card for purchases and want to pay it back on receipt of the statement to avoid interest, it's crucial to know how many interest free days are in a billing cycle.
That's why it's important to check the small print of the credit card contract to understand what the interest free period is on that card and when interest will start to be applied.
There are a couple of other elements to be aware of:
- The full statement balance must be repaid in order to benefit from the interest free period
- Interest free periods generally only apply to purchases rather than balance transfers or cash transactions
- Standard interest free periods should not be confused with special rates that are sometimes offered to customers to provide 0% on purchases for a certain number of months (see above)
7. Minimum monthly repayment
Every credit card agreement will come with a minimum monthly repayment that must be paid otherwise the cardholder will be considered to be breaching the conditions of the card.
The contracted monthly minimum varies depending on the card provider, but it will be calculated in one of two ways:
- A percentage of the amount owed
- A flat fee
There's no personal choice on this monthly repayment calculation - the credit card provider will work out the largest of the two figures and that will be the minimum repayment for that month.
At the least, this figure will be 1% of the outstanding balance. In practice, it's likely to be more for reasons we explore below.
If there is a possibility that a customer won't be able to meet the minimum repayment one month, it's crucial to talk to the card issuer and try to come with a short-term solution rather than just skipping the payment without warning.
Minimum repayments and persistent debt
The low minimum monthly repayment figure of 1% across the industry generally is much lower than we saw in the past when 5% was the norm.
Yet 1% was set as the minimum in 2011 amid a flurry of measures designed to ensure customers were in control of their credit such as banning upfront special offers with store cards and issuing annual credit card statements.
More recently, however, we have also seen credit card providers compelled to help customers get on top of their debt.
If a customer is classed as being in persistent debt with their credit card, they are paying off more in fees and charges than the original amount they borrowed. Lenders must contact customers to encourage them to increase their repayments and may also warn them that the card may be suspended if changes aren't made to the debt repayment plan.
So, while it's always a good idea to pay more than the minimum repayment anyway, the advent of persistent debt rules make it both more likely that credit card providers will press for repayment schedules that are less likely to lead to customers falling into persistent debt and that customers paying the minimum will be encouraged to pay more.
8. Allocation of payments
Customers who do not pay their outstanding balance by the end of their interest free period each month will find their monthly repayment is put towards the most expensive debt first.
This means our credit card provider will allocate money towards the debts that are costing the most in interest first.
So, if we have a 0% promotional rate on purchases but we're being charged interest on cash withdrawals, the monthly repayment will be allocated to the cash withdrawal segment before going towards the purchases covered under the 0% promotional rate.
For example, a balance of £1257.78 could break down as:
- £9 in interest charges - accruing 22.9% p.a. interest
- £40 for cash withdrawals - accruing 22.9% p.a. interest
- £208.78 in purchases - accruing 16.9% p.a. interest
- £1,000 as a balance transfer on a promotional rate of 0%
If a payment of £50 was made towards this balance, the payment would repay the interest charges, the cash withdrawal, and £1 of the purchase balance, leaving £207.78 in purchases and the £1,000 balance transfer at 0%.
This is designed to help customers pay off more expensive debts first, and it's been in existence since early 2011, after a consultation between Government and the credit card trade body the UK Cards Association ruled to protect cardholders.
Before that, we regularly saw deals that persuaded customers to sign up to cards that paid off the cheapest balances first and let the most expensive ones accrue interest for longer.
While this was outlawed, it's still good to fully understand the principle of payment allocation and how it affects credit card balances.
Promotional rates
When a cardholder makes use of two or more promotional rates at the same time, allocation of payments can occasionally become a problem.
This is because there are two schools of thought used by credit card providers in this instance. Providers can allocate payments where there are two or more promotional balances either to the balance:
- with the highest eventual interest rate at the end of the promotional offer
- with the shortest promotional period
The shortest offer approach seems to make the most sense and is used by most providers, but not all.
The problem with repaying 'the highest eventual interest rate first' is that if the cardholder made a £200 monthly repayment for six months they might well expect that, at the six month mark, the 0% purchases balance would be paid off entirely. But more or less the whole purchases balance would start accruing interest because payments were first allocated to the balance with the highest eventual rate first - which is usually the balance transfer.
There are a few ways around this.
Cardholders could resolve to just pay off the purchases balance in full when it starts to accrue interest, paying as little as possible to the provider.
Alternatively, they could consider holding two separate credit cards, one for repaying existing card debt and another for any new spending. Although the simplest option may be to find an equal length 0% on balance transfers and purchases.
It's worth always checking the small print before relying on a certain order of payments - while most do, not all providers will repay the shortest 0% period first for example.
9. Late payments
Making a late payment or missing a payment on a credit card can cause difficulty further down the line and may lead to a card provider pulling the plug on the whole credit card.
Depending on the terms and conditions of a specific credit card, customers may find that late payments mean:
- Being charged a late fee (this can be compounded with further late fees)
- Interest rates may rise if they were on a 0% promotional deal that has been breached or the lender believes they are now a greater credit risk
- The late payment can appear on credit reports for up to six years and may affect a customer's credit score
So, wherever possible, make at least the minimum repayment on a credit card by the due date and speak to a lender if this isn't going to be possible.
The longer the issue is left unresolved, the more damaging it could be to a credit score.
We've got more on what to do if you can't afford to pay all your bills and which debts are considered to be priority debts.
10. Dormancy fees
It used to be common for credit card providers to charge customers for the privilege of not using their cards. These were called dormancy fees or inactivity fees.
The principle behind them was the idea that card issuers incurred costs from the administration of offering cards even if customers were not using them.
However, the introduction of many dormancy charges from providers came at a point in 2007 when a cap was imposed on credit card fees, meaning profit margins for providers were slashed and dormancy fees were a way of recouping some of that.
Unintended consequences like this don't just affect the credit card industry - we've also seen incidences of overdraft providers increasing costs in one area to cover those lost by regulation in another.
In terms of credit card dormancy fees, they are now so rare that most customers will never come across them - but it's worth knowing about this hidden charge just in case.
Summary: Be credit card aware
Education around credit card terms and what they mean for customers has become clearer in recent years. Providers are now much more likely to be transparent about what they offer, and it keeps the regulators happy if customers know what they're signing up to.
The difficulty is that the jargon associated with credit cards can still be off-putting and confusing, so it's worth stopping to look up something that isn't quite clear before we sign up to something that isn't right for us.
When looking at credit card terms, ask the following questions:
- What will this cost me and is it worth it?
- How quickly can I pay back the credit?
- How is this going to affect my credit score, especially if something doesn't go completely to plan?
Many of the credit card terms we've discussed in this guide come back to those key questions, and customers should be careful never to sign up to credit that is unaffordable.
Use our free tool to compare credit building credit cards designed for those with poor credit scores.
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