Why 0% credit cards cost you money

When it comes to credit cards, many borrowers chase the longest 0% balance transfer deals available. But these aren’t always the best deals for everyone.

When it comes to credit cards, most savvy borrowers spend their time chasing the longest 0% balance transfer deals available. But these aren't the best deals for everyone. For some of us they work out more expensive than simply opting for a low-rate credit card.

Watch out for fees

It's the balance transfer fees that you have to watch out for. If you only have a small balance to pay off, then the fee can end up costing you more than if you had simply kept your balance on an interest-charging card.

For example, if you owe £1,000 on a credit card that charges 10.7% APR and you pay off your balance in six equal monthly instalments, then you'll pay £30 in interest, says Neil Faulkner on Lovemoney.com. Whereas if you had moved the £1,000 onto a 0% balance transfer deal with a 3% fee, then paid off the balance over six months (assuming the 0% deal lasts that long), you'll also have paid £30 in this case, in upfront fees rather than interest.

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In other words, in this instance, if your existing interest rate was below 10.7%, you'd be better off sticking with the interest-charging card than going for the 0% one.
M&S Money has created a helpful table that shows what a balance transfer fee equates to an annual equivalent interest rate.

Swipe to scroll horizontally
Six months7.0% AER8.9% AER10.7% AER14.5% AER
Nine months4.9% AER6.1% AER7.4% AER9.9% AER
One year3.7% AER4.7% AER5.6% AER7.6% AER

So if you have a credit card balance which you know you can pay off quite quickly, then a low-rate card may well be cheaper than a 0% deal just make sure that it won't charge you a fee for balance transfers.

Best cards for large debts

However, if you have a large debt to clear, then a 0% deal may be the best thing for you, as the balance transfer fee will be lower than the interest charges on a normal credit card.

But if you have a large debt and know that you won't pay it off within the 0% period then bear in mind that at the end of the period you'll either have to pay another balance transfer fee to shift the remaining debt to another 0% card, or you'll be stuck paying interest at the provider's standard rate. In this instance you might be better off going for a low interest rate card in the first place and saving yourself the cost and hassle of multiple transfers.

Pay your cards off in the right way

The main way that credit card firms make their cash other than by charging extortionate interest rates to those who don't shop around is through a thing called the negative payment hierarchy. 

This nets card companies more than £500m a year, according to Nationwide which also happens to be the only firm that doesn't apply it.

Negative payment hierarchy refers to the order in which your debt is cleared. What it means is that any payments made to your card go towards paying off the debt which is incurring the lowest interest rate first. Say, for example, you have a credit card with a 0% balance transfer deal for 12 months, but a standard rate of 16.6%APR for purchases. You have £1,000 outstanding on the card, having transferred your balance from another card. But you use the card to buy a £200 television.

The £200 will sit and accrue interest at the card's purchase rate of 16.6%APR until you have completely paid off the £1,000. So even if you pay off £200 of your debt straight away, you'll have paid off £200 of the existing £1,000 debt rather than the £200 purchase.

The easy way to avoid this is to have one card for balance transfers and another card for purchases. This way you can avoid paying any interest at all as long as you don't mix up the cards and pay for something new with your balance transfer card.

Ruth Jackson-Kirby

Ruth Jackson-Kirby is a freelance personal finance journalist with 17 years’ experience, writing about everything from savings 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.