Defaqto

What's the difference between a credit card, store card, debit card and charge card?

Credit card

A credit card enables you to make purchases and not have to pay for them for up to 45-56 days after the purchase was made.

The interest free period gives you time to get the funds ready to pay the bill, during which time your hard earned cash should have earned some interest.

If you have a series of credit cards with different payment dates, you can stagger purchases by using the different cards, thereby maximising the effectiveness of the interest free period.

Debit card

A debit card is usually linked to a bank or building society current account. When used for purchases, the money is deducted from your bank account the same (or next) day.

Charge card

A charge card will normally involve you paying a membership fee. It allows you to charge your purchases to an account which has to be paid off in full each month.

Store card

These are offered by retailers such as Next and Austin Reed. They are effectively a credit card which can only be used in the retailer’s outlets and are best avoided as they tend to charge exorbitant rates of interest (up to 30 per cent APR in some cases).

Affinity / charity card

These are like any other credit card, except that a charity receives a small amount of money when you open the account and a percentage of all subsequent transactions.

Cashback card

These cards pay you back a small percentage of your total annual spend.

How much should I pay off each month?

To gain maximum benefit from a credit card, it is best to pay off the entire outstanding balance each month. Otherwise, you will start to rack up huge debt because your minimum payment will be used to pay off the cheapest debt first, and the most expensive debt last..

You are usually required to make a minimum payment of the greater of 3 per cent of the outstanding balance or £5 each month.

A few card issuers allow minimum payment of as little as 2.25 per cent each month, which is very dangerous for the reasons outlined above.

If you use a credit card to withdraw cash you will be charged interest at a higher rate than for purchases and balance transfers and interest starts clocking up from the date of withdrawal, so using your credit card for this purchase is best avoided at all costs.

How is the interest calculated?

Different transactions are charged at different rates. For instance, purchases will normally be charged at an annual interest rate of between 6 and 20 per cent (although providers can charge more or less than this).

Some card issuers offer very low or 0 per cent interest rates for an introductory period of typically six to 12 months as a way of drumming up new business. These can be excellent deals, providing you pay off the outstanding balance in full or transfer the balance to another card before the ‘payment due’ date.

You should also check the rate payable once the introductory period comes to an end (known as the ‘revert to’ rate).

Balance transfers

Balance transfers of existing debt to a zero interest rate card used to be free, but many issuers are now charging upfront fees for such transfers. For instance, GE Money is currently charging 2 per cent of the amount transferred, subject to a cap of £50.

Which type of card should I choose?

If you have a squeaky clean credit history, you may be able to switch from one zero interest credit card to another at the end of each interest free introductory period.

But if you know that you will not be able to pay off the outstanding balance each month, the most important feature to look out for is the annual percentage rate (APR) for purchases and balances transfers over the long term (often referred to as the ‘lifetime’ rate).

If, on the other hand, you regularly pay off your entire bill each month, the APR is irrelevant as you will never incur interest charges. In this case, the rewards and benefits provided by some cards are more important.

For instance, with a Goldfish card, you earn points every time you spend and can exchange these for discounts and vouchers which you can use at various high street retailers, such as Boots. Others, such as the Sainsbury’s Bank Visa card enable you to clock up air miles.

Some cards offer cash backs of 0.5-1 per cent of the amount spent, but there are often strings attached and in recent years card issuers have been reducing or withdrawing this benefit altogether.

For instance, the Alliance & Leicester Moneyback Visa card gives money back on purchases at a rate of 0.50 per cent up to £20,000, but only if you have an Alliance & Leicester premier current account or a mortgage with the bank.

Other cards offering cash back deals at the time of writing (March 2008) include Abbey Cashback credit card, American Express Blue, American Express Platinum, Bank of Ireland Moneyback Mastercard and Capital One Circle Rebate.

Other fees

Cash withdrawals

Cash withdrawals are normally charged at a higher rate of interest than for purchases and balance transfers and interest starts to clock up from the time of withdrawal so it is much better to use a debit card for cash withdrawals if at all possible.

Foreign transactions

Using your credit overseas can work out extremely expensive if  you use the wrong card. Most credit cards charge foreign currency conversion charges of typically 2.75 per cent and other fees whenever you use the card abroad.

However, a few cards, such as the Nationwide Visa card and Lombard Direct, don’t charge the foreign currency conversion charge and are highly competitive for credit card purchases abroad.

For ATM cash withdrawals abroad, it is best to use a debit card linked to one of Nationwide’s current accounts, such as its Flex Account as these don’t carry foreign exchange holdings either.

If you require specialist services while abroad, there are a number of fee paying charge cards such as American Express and Diners Card, but they are best suited to frequent travellers and those on business expenses.

Admin charges

Credit card issuers levy ’default charges’ for late payments (typically £15) and for going over the credit limit (typically £12-£15). Administration fees for returned cheques or failed direct debits also cost around £15-£20.

If your card issuer is charging you more than these amounts you should make a complaint as the banks have recently been ordered to limit penalty charges to an amount that reflects the cost of providing these services.

Some cards charge an annual fee, but these can be avoided as there are still plenty of fee-free credit cards.

Credit card cheques

Like cash withdrawals, credit card cheques are best destroyed on receipt. If used, they incur handling fees, interest starts building up straightaway and the interest rate charged may be higher than for purchases.

Payment protection insurance (PPI)

Payment protection insurance is a voluntary insurance designed to help you pay your credit card bill in the event that you are unable to work through sickness, redundancy or unemployment.

But this insurance is often bought unwittingly and has been widely mis-sold, with only 40 per cent of claims being met by some providers.

PPI typically costs 0.7- 0.8 per cent a month per £100, so a PPI charge of 0.76 per cent will cost you 76p per £100 of cover. Anyone taking out PPI cover and who makes only the minimum monthly payment each month will see their balance creep up over time, even if no new purchases are made.

Some providers have cut their minimum monthly repayment requirement to 2 per from 5 per cent, so that a combination of PPI costing 0.76 per cent and the interest payable on transactions, could be more than the minimum amount you are obliged to pay.

Cards which consumers should beware of in this respect are Leeds & Holbeck building society’s Mastercard and the credit cards from Barclays, More Than and Create. Card issuers which require higher minimum monthly repayments (and therefore avoid this conundrum) include MBNA, Abbey and Virgin.

How are payments applied to my outstanding debt?

How your payments are applied is complex, particularly if your debt consists of a mixture of purchases, balance transfers, cash withdrawals and fees.

This is because card issuers typically apply payments in the following order of priority (but you should check the terms and conditions of your card as terms may vary):

1. 1. Insurance premiums (for payment protection insurance)
2. 2. Interest
3. 3. Charges or fees (for foreign exchange transactions, missing payments, copy statements etc)
4. 4. Balance transfers and promotional transactions (those with the lowest rates of interest first)
5. 5. Retail purchases
6. 6. Cash transactions

If you only make the minimum, or part payment of your outstanding balance each month, remember that your payment may only cover the first two or three items on this list and may not cover any of your retail purchases or cash transactions.

Generally speaking, card issuers apply payments to items incurring the lowest rates of interest first and to the most expensive transactions last.

Credit reference agencies

Switching from one card to another at the end of each introductory deal is fine, but remember that each time you apply for credit, you leave a ‘footprint’ on your credit records which are held by credit reference agencies such as Experian and Equifax.

When you apply for a new credit card, the card issuer will check your credit history with the reference agencies to establish your record of applying for, and handling, debt.

Very frequent applications for credit could count against you, but providing you have managed your debt responsibly, there should not be a problem.

You are much more likely to be rejected for credit if you have county court judgments against your name, have not lived at your current address for very long and are not on the electoral register. A recent switch to self employment could also lower your credit rating.

Factors that may boost your credit rating are being married, a homeowner (preferably for several years at the same address) and being employed (rather than self employed).

Theft, loss or misuse of your card

Identity fraud is a rapidly growing crime, so you should always keep your credit card statement carefully in a safe place or shred it.

Always check your statement against transaction slips to ensure that no one is using your card without your knowledge. There has been a huge upsurge in ‘card not present’ fraud, whereby stolen or cloned cards are used for telephone and online purchases.

Never disclose your PIN number to third parties and report lost or stolen cards immediately.

If your card is lost, stolen or fraudulently used, you should report it immediately to the card issuer by phone.

You will not be liable for more than the first £50 (providing you have not behaved negligently).

However, if your card is misused through your own fault, you may be liable for all losses.

Advantages of credit cards

Introductory zero per cent deals are a no-brainer, providing you have the discipline to set aside sufficient money to pay off the bill in full at the end of the nil charge term.

Transfering outstanding balances to another card at the end of each zero per cent deal can be a good idea, providing you understand the cost of doing so.

Many providers charge  2-3 per cent of the amount transferred and any special deal on balance transfers may be for a limited period - typically 6-12 months, so you need to remember to pay off the balance or switch again at the end of the deal.

Credit cards can offer valuable protection against breach of contract or misrepresentation by the provider of the goods and services.

To claim redress under Section 75 of the Consumer Credit Act 1974, the purchase must have been made on a credit card (not a debit card, charge card or credit card cheque) and been for a cash price of more than £100, but less £30,000.  Since March 2006, the Act has also applied to credit card purchases made abroad.

If you are a heavy spender, you will benefit from any reward scheme on offer, whereby you clock up bonus points, air miles or cash back each time you spend on the card. But these schemes are usually graduated and often have a maximum ceiling spend.

Money you owe on a credit card counts as unsecured debt. This means it is not officially  secured against your home, as mortgage debt and certain other loans are.

So if you default on credit card debt, the card issuer will not be able to force you sell your home in the first instance, although if you are bankrupted because of other debts, your credit card debts will be taken into account by the insolvency practitioner.

Disadvantages of credit cards

Credit card charging methods can be a minefield for the unwary. Unless you are willing to take the trouble to understand how your credit card provider handles your debt, you should steer well clear.

As explained above, different types of transaction attract different rates of interest and payments are applied to your account in a strict order of priority.

This means that if you do not pay off your bill in full each month, your payment will be used to pay off the least expensive debt first, and the most expensive debt last.

The combination of payment protection insurance and very low minimum monthly repayments can be particularly pernicious and lead to spiralling debt for unsuspecting cardholders.