This article is taken from Merryn Somerset Webb's free weekly personal finance email, Money Sense. Click here to sign up now: Money Sense
Credit Action released a particularly nasty set of figures on debt in the UK this week. Total UK personal debt stood at £1,380bn at the end of September.
That's 10% higher than at the end of last September. The average household debt excluding mortgages across the UK is £8,681 and the average individual consumer debt via credit cards, motor and retail finance deals, overdrafts and loans is just over £4,500.
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And the Christmas shopping season hasn't even started yet: every year a third of people say they go into debt to make it the 'best Christmas ever' and one in ten of those are still in debt by the next Christmas. This is hardly surprising given that most of these borrowers buy with their credit cards.
The perils of plastic
Credit cards are terrible things. The main problem is the interest rates they charge. They are far too high, of course, but they are also almost impossible to figure out. And not just for the financially illiterate, for everyone. The obvious way to compare credit cards is to look at the annual rate of interest they charge (APR).
But the problem with this is that different companies calculate it in different ways (there are at least 14 methods according to Which? Magazine) so knowing the APR isn't much good. Some cards start charging you interest the second you buy something, and some when the money leaves their accounts; some don't charge you for 30 days and some for longer; some charge interest on interest accrued in earlier months; some do not; and so on.
The result? Two cards that appear to charge the same rate of interest could in fact cost you wildly different amounts even if used in the same way. It all adds up to a slightly ridiculous lack of transparency.
Next up on the list of bad things about credit cards is the fact that credit card companies have set minimum repayment levels so low that if you pay only what they require you to pay you will be in debt pretty much for ever.
You could be in debt for 32 years
Uswitch recently published research showing that if someone with the average credit card debt of £3,138 paying the average APR available in the market (15.2% at the time) made only the minimum payment each month (i.e. 2% of the balance) it would take them a shocking 32 years to pay it off. If you paid not 2% but 3% it would take 16 years and 11 months, assuming an interest rate of 15.10%. In the first example the total amount of interest you would pay would be £4,275 (significantly more than the original debt) and in the second it would be £1,969.50.
See how much money the banks make out of letting you get away with paying your debt off so slowly? Low minimum payments make debt seem more affordable to you but to the credit card company executives they just spell pure profit.
The final thing on the list of charges against cards is the many non-interest charges that credit card companies have invented. They charge you a minimum of £12 if you pay your minimum payment late regardless of the size of your balance. So if you owe them £70 for a coat you picked up in the sales you could end up paying out almost 30% of the price again in late payment fees if you aren't careful.
You'll also very often pay a 2% charge if you use your card to withdraw cash (you really shouldn't be doing this) and another 2.5% 'loading charge' if you use your card abroad. It all adds up: according to moneysupermarket.com credit card customers pay a huge £116 each a year in penalty fees. Credit card companies go to great lengths to persuade you that being a card holder is somehow a privilege but once you add up all the charges it doesn't seem so much like one, does it?
But credit cards aren't all bad
Still, I'm not suggesting that you cut up all your cards. You should certainly cut up any store cards (according to research from Alliance and Leicester 23% of people say that they use store cards to pay for their Christmas shopping). They charge horribly high rates of interest, often well over 20% a year and at their worst over 25%, and there is absolutely no reason to have them.
You usually get offered 10% or so off a purchase if you take out a store card as you buy, but why do you think the retailers are happy to do this? Because they know that like as not you'll either forget or not be able to pay off the debt you've taken out. Then they'll be able to start charging you obscene amounts of interest. And that, they know will, will soon make up for the couple of quid they gave you in discount.
Ordinary credit cards that you can use anywhere, on the other hand, do have a few plus points. It's good to have one for emergencies and there is also a case for having one with a very low credit limit to use when you shop on the Internet (a low credit limit reduces the level of mischief anyone can get up to with your card if they manage to steal the details and hence the level of stress you will have to deal with when sorting it out).
Finally it is worth noting that credit cards offer one very wonderful thing, valuable consumer protection. Buy something worth more than £100 and less than £30,000 and the card company is as liable as the retailer if anything goes wrong. If your item is faulty or isn't delivered as it should be for example you can go straight to your credit card provider instead of or as well as the supplier to complain.
Until this week there was some doubt about whether this protection held if you had bought the item abroad but last week the House of Lords confirmed that it does. So if you are taking advantage of the weak dollar (now at a 26 year low relative to the pound) to do your Christmas shopping in New York there is a good case for doing so with a credit card - as long as you pay it off at the end of the month.
If you want to get a credit card for occasional use and you're sure you'll use it responsibly - or you're looking to save money by switching to a 0% offer - you can compare different providers by the level of interest paid on balance transfers or purchases here: Best deals.
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