Don't drown in credit-card debts

Ruth Jackson investigates the best way to clear your credit-card debt, and explains the golden rule of zero-percent-interest cards.

Paying off a £5,000 debt on a Barclaycard could now take nearly 100 years. Britain's largest credit-card issuer has announced that some of its near-12 million customers will have their minimum repayment cut from 2.25% to 1.5%. "We are doing this to help," a spokesman for the company told The Daily Telegraph. "We understand that some customers may appreciate this additional flexibility during the current economic circumstances."

That's all very well. But if customers actually take advantage of the new minimum repayment level, they'll find themselves stuck in debt for far longer and paying a lot more interest. For example, a £5,000 debt paid off at the old minimum repayment of 2.25% would take 31 years and accrue total interest of £5,900 over the period. At the new 1.5% rate, the same £5,000 debt would take 98 years to repay and accrue £22,300 in interest in the process. So what's the best way to clear your credit-card debt?

As the example above shows, the key rule is not to just to pay the minimum each month. As this is a set percentage of the debt, the minimum payment falls along with the debt, meaning you won't ever be making any real dent in the pile. A far better idea is to set up a direct debit for a set amount. If the £5,000 mentioned above was paid off at £100 a month it would take less than seven years to clear, with interest of £3,000.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

You can cut that even further by switching your credit-card debt onto a 0% interest card. You will have to pay a small balance transfer fee but it's well worth it, as you'll stop racking up added interest, meaning you can really make some headway into clearing the original debt. And if you switch cards every time your 0% deal runs out so that your debt is always on a 0% card, you could clear that £5,000 debt in just over four years at £100 a month. The best deal available now is Virgin Money's card, which offer 0% for 16 months.

Just remember the golden rule of 0% cards. Don't use them for purchases. Most 0% cards are only 0% for balance transfers and operate a negative payment hierarchy. This means the debt with the lowest interest rate is paid off first. So if you buy something on the card it will start accruing interest at a typical credit-card interest rate 16.6% APR on the Virgin Money card and will keep gaining interest until you have paid off all your 0% debt.

Even if your card offers you 0% on purchases, this deal usually doesn't last as long as the 0% on balance transfers. So when the 0% on purchases deal runs out, any debt left over from purchases will start attracting interest while you pay off the cheaper balance transfer debt. So make sure you have a separate credit card for purchases and pay that off in full each month to avoid ending up with two large credit-card debts instead of one.

Ruth Jackson-Kirby

Ruth Jackson-Kirby is a freelance personal finance journalist with 17 years’ experience, writing about everything from savings accounts and credit cards to pensions, property and pet insurance.

Ruth started her career at MoneyWeek after graduating with an MA from the University of St Andrews, and she continues to contribute regular articles to our personal finance section. After leaving MoneyWeek she went on to become deputy editor of Moneywise before becoming a freelance journalist.

Ruth writes regularly for national publications including The Sunday Times, The Times, The Mail on Sunday and Good Housekeeping, among many other titles both online and offline.