It’s been a tumultuous week for our finances. In the space of a little over seven days, we experienced a major rise to the Bank of England interest rate, a mini-budget that caused panic on the financial markets, the value of the pound plummeted and as October began, the price of energy significantly increased. You’d be forgiven for feeling a little overwhelmed by all of this. I know I do.
How do we make sense of all this chaos? Well, the first thing not to do is panic. There’s a lot to worry about, but decisions made on the spur of the moment can often be pricy mistakes. Remember those offers to freeze your energy bills are £5,000 a year? In retrospect, that wasn’t the best of solutions.
Yet it’s natural to panic when it looks like your finances are running away from you despite it being no fault of your own. Every one of my friends has asked me this week what to do with their mortgages. Others questioned whether they should go on holiday abroad. Most asked for some advice on cutting costs.
Borrowing your way out of an emergency or difficult financial situation might seem like a practical solution if things are looking a bit rocky short term. Yet with loan rates on hold (and likely to be much higher) and high-cost credit options being nothing more than payday loans over a longer duration, it’s hard to know where to turn.
Which brings us to credit cards. An expensive way to borrow if you don’t have discipline, but a great way to protect your purchases – and to transfer debts (in effect, borrowing money for free). There are pros and cons. Here’s my view.
Credit cards – the costs and the benefits
Back in 1966, the first credit card was launched in the UK by Barclays, revolutionising the way we spent money forever. It also changed the way we think about debt. When we spend money on a credit card, we are in effect, borrowing it. Yet psychologically, because we also have debit cards sitting alongside credit cards in our wallets and bags, it’s easy to equate the credit card as a source of money that belongs to you – as opposed to a pricy way to borrow.
And it certainly is pricy. Average interest rates on many of the big brand credit cards are varying between 22% to 23% at the moment. If you don’t have good credit, you’re looking at rates between 22.9% to just under 35%.
This matters in these challenging times because interest rates can be increased during your contract, in line with the Bank of England interest rate, which is predicted to keep rising. Lenders aren’t necessarily going to rush to increase interest rates on credit cards though. They’ve been stung by criticism in the past about irresponsible lending and overcharging. What matters is this could happen and borrowers should be aware of this as a possibility. As a nation, we are certainly still packing the plastic, with £0.7 billion being borrowed on credit cards in July and August and £1 million in June. This is the highest level of growth in credit card spending since 2005.
So given that credit cards are expensive, make it easy to get in to debt and charge interest in confusing ways, are they worth having? Here’s my view
A few advantages to credit cards
You can claim back money from the card provider if something goes wrong
The Consumer Credit Act became law in 1974 and with a couple of amendments since, it still gives people who spend on credit cards a level of protection with their purchases that simply doesn’t exist elsewhere.
If you pay for goods or services on a credit card that cost between £100 and £30,000, the credit card provider is jointly responsible, along with the supplier of the goods or services, for any breach of contract or misrepresentation. This can involve goods not turning up, items that are damaged or don’t do what they are supposed to do or situations where you’ve been misled by the supplier.
What this means in real terms is you can pay using a credit card and as long as you meet certain criteria, you’ve got a way of getting your cash back from the card provider, even if the firm that you’ve paid money to goes bust. This proved invaluable over the pandemic as people struggled to get refunds from travel agents, wedding venues and countless other businesses ignoring the rules about refunds for cancelled services.
Like most laws though, the Consumer Credit Act is creaking under the pressure of our rapidly changing world, so there are lots of caveats and exceptions that can catch people out. Top of the list – you have to buy direct from the provider of goods and services. For example, that means using online travel marketplaces to buy a holiday might not give you protection. There’s also a big debate about whether paying using PayPal affects your rights (most of the time it does under the current reading of the law). So think before you shop.
0% balance transfers
If you’ve got a credit card debt, or debts, you might be able to consolidate them by switching the outstanding money on to a 0% interest credit card. Some credit card firms allow you to transfer store card balances or even pay off loans (but not all of them, so check).
Have no doubt about it, this is the cheapest way to shift your debt to an interest free loan, though you will have to pay a fee to do so per transferred balance (usually an around 3 to 5 percent of the total amount you are transferring). But here’s where you need to apply that discipline I mentioned.
If you’re planning on transferring a balance, get out the calculator. Work out the total amount you’d like to transfer (if possible). Next, work out what the percentage fee would be to transfer the money from each debt balance. Finally add together the fees and have a think about whether it’s cost effective to transfer the money or stick with the credit card APR. This can be hard to tell, but if you owe quite a bit, it’s often more advantageous to transfer. You should also factor in the duration of the interest-free period on the card and work out what you need to pay each month to clear the whole amount before the interest kicks in.
Next up, find the best card for you. Depending on your finances, decide if you want the longest zero interest period (bear in mind the APR when this ends may be higher than other cards) or a card with other benefits. On many comparison sites, you have the option of running a ‘soft’ credit check. This is where the lender takes some basic information from you which will tell it if you are likely to pass the application process or fail it. Crucially, soft checks don’t go on your credit file, so a failed application shouldn’t have a negative impact if you apply elsewhere.
Once you’ve got the card, cut it up. Then cut up all of the old ones. Credit card companies know that if that card goes in to your bag, there’s a chance you’ll use it (and pay a high APR on what you spend). We all think we can beat the odds when it comes to credit card spending. The majority of people don’t. If you want to have a clear credit card for emergencies or payments to give you section 75 protection then lock the card in a drawer away from temptation – and don’t save the details to online shops and payment services.
A word of warning
The problem with credit card spending is it’s a more expensive way to spend than many other forms of lending, with the exception of high-cost credit and your innocent looking but super expensive overdraft facility.
We all believe that we can wrest control back of our spending, but equally we can all be caught out by unexpected life events and situations. If you’re experiencing a short-term problem, don’t borrow your way out of it. Speak to the businesses you owe money to and see if they can give you a little breathing space while you sort out the problem. This is free and all you’ll need to do is give a bit of information about your finances.
Featured in Times Money Mentor – Martyn James