CREDIT CARDS

What you should know before applying for a card

Credit cards let you choose how much you borrow (subject to an upper limit) and how quickly or slowly you pay back the loan.

Compared with most other types of borrowing, credit cards are very convenient. Once you have a card, you simply use it to pay for goods and services without having to request a new loan each time.

Credit cards are issued by banks, though lots of other organisations - for example, newspaper groups and motoring associations - have teamed up with a bank to offer their readers or members an own-brand credit card. The complicated system of making sure credit card payments all reach the right destination is handled by specialist organisations such as Visa and Mastercard.

Charges

Each month, you receive a statement setting out what you have borrowed using your credit card - this is made up of your purchases made during the last month using the card, any balance carried forward from the previous month and any interest charged.

If you pay off the whole amount you owe, usually there is no interest charge. So, provided you pay off the full balance every month, credit cards give you interest-free credit for, say, a maximum of 56 days.

If you do not pay off the full amount, you are charged interest on the whole lot. Different cards work in different ways, so interest might be charged from the statement date or from the date of each purchase.

Each month, you must pay off at least a minimum amount - for example, £5 or 3% of the balance, whichever is greater. If you miss a payment, there may be a penalty charge.

A few cards charge an annual fee - say, £10.

What a credit card company charges you for the use of its card can be expressed as an 'Annual Percentage Rate' or APR. An APR takes into account:-

• the interest you must pay;
• any annual fee you must pay;
• when and how often you pay the interest and any fee.

You do not need to know how to work out an APR. The important thing is that APRs show the cost of borrowing on a standard basis so you can compare one APR with another.

The APR also lets you compare the cost of credit cards with other types of borrowing. Of course a loan with a lower APR is cheaper than a loan witha higher APR.

The APR does not take into account charges you might have to pay, such as a charge for missing your monthly repayment.

To lure customers away from competitors, many card issuers offer special, low introductory interest rates - for example, 1% a year for the first six months, or even 0%.

Check the small print of these offers carefully. Often, it applies only to any balance you transfer from another card, not any new purchases you make. And, your repayments are set first against the transferred balance, not against new purchases, so you might not get the benefit of the offer for the full six months.

Repayments

If you pay only the minimum amount each month, it can take a very long time to pay off a credit card bill.

For example, suppose:

you have a debt of £1,000;

interest is charged at 18% a year; and

you pay off a minimum 3% (or £5 if greater) of the outstanding balance each month.

It would take you 13 years to pay off the whole balance and your repayments would total £1,772.

Although credit cards can be a convenient and cheap way to borrow for a short period as they usually have a period of free credit (25 to 50 days), they are an expensive way to borrow over the long-term.

Small print

Credit cards come with a lot a small print. Particular areas to check are:-

• What is the period of free credit?
• From when is interest charged - the statement date or the date of purchase?
• Will you be charged if you miss a monthly payment? How much?
• Is there an annual fee?
• What happens if you can't keep up even the minimum payment?

Risk

The biggest risk with credit cards is running up debts you can't afford to repay. Making only minimum payments each month is an extremely expensive way to borrow. If you don't keep up at least the minimum payments, the issuer can demand that you pay off the whole outstanding balance immediately. If you can't do this, the issuer could take you to court. The court would probably order you to make regular repayments based on what you can afford or could allow the lender to seize and sell some of your possessions to recover the debt. You are likely to find it hard to get another loan or credit card if you have a court order against you.

If you find yourself experiencing difficulties paying your credit card bill speak to your credit card company. Do not put this off. Credit card companies do not want you to default on your repayments and will be prepared to talk to you about how to solve any repayment problems you have.

Debt counselling offers more advice on dealing with debt problems. The Office has developed a range of Money Management Tools to help you calculate how much you will pay back when you borrow money.