Why you should fear the MMR!

It can take decades to pay off card debts, thanks to low minimum monthly repayments.

In my view, credit cards are much like Marmite. Just like the brown, sticky yeast extract, you either love or hate your plastic.

Two in three British adults have at least one credit card, and most cardholders use them sensibly and carefully. Sadly, a sizeable minority -- perhaps a third of all card carriers -- fails to grasp just how dangerous they can be.

As a result, these card players have their wealth sliced by these double-edged swords.

Weapons of money destruction

The over-riding point to note about credit cards is they are an incredibly expensive way to borrow money, especially over long periods.

Today, the typical yearly interest rate charged by credit cards on purchases is over 19% APR. However, the Bank of England's base rate has been 0.5% a year since March 2009. This strongly suggests that card issuers are ripping off those who borrow on credit cards.

In fact, thanks to high interest rates and low minimum monthly repayments (MMRs), I know that credit cards are WMDs: Weapons of Money Destruction.

Beware the MMR

Twenty years ago, early in my career in financial services, minimum monthly repayments were much higher than they are today.

Typically, card companies would demand that you repay at least a tenth (10%) of your outstanding balance each month. With MMRs this high, debts would be quickly whittled away, with not much left after one year of repayments.

Then along came what I called the 'American Eagles' -- US card companies such as Capital One, Citibank and MBNA -- who aggressively entered the UK card market. These US card companies introduced much lower MMRs, typically 5% of the outstanding debt. UK banks quickly followed in their footsteps, lowering their MMRs to 5% or below.

Today, a typical MMR on a credit card is between 2% and 2.5% of the outstanding balance. Therefore, you'd expect any balance to be largely cleared after, say, five years or so, right?

Wrong! In fact, even a balance of just £2,000 can take most of your working life to clear, thanks to these ultra-low MMRs.

A 24-year debt

Let me show you how this works in practice.

Let's say that you owe £2,000 on a credit card which charges a monthly interest rate of 1.5% and has an MMR of 2.5%. Here's how your balance goes down during the first six months: 

As you can see, your total repayments over six months come to nearly £293. However, your balance has reduced by just £117, thanks to nearly £176 in interest charges.

What's more, as your balance goes down, so too does your MMR. This continues it drops to a minimum of, say, £5 a month. Thus, most of your monthly repayments are wiped out by interest, especially in the early days.

Having studied Maths at degree level, I keenly built an Excel spreadsheet in 2005 to model credit-card repayments. According to my model, the above debt of £2,000 would take 283 months to repay, which is nearly 24 years. What's more, the total interest bill would be £2,710, which is far more than your initial £2,000 debt.

In short, low MMRs are great for lenders, but terrible for borrowers.

Two ways to fight back

The first way to end this rip-off is to stop paying interest by switching your debt to a 0% balance transfer. This gives you nearly two years of interest-free credit, in return for a transfer fee of around 3%. You can learn more about this card shuffle in Avoid interest for 22 months.

Second, never, ever pay the MMR. Instead, set up a direct debit or standing order for a fixed monthly sum. I suggest a monthly repayment of 4% of your balance, which would be a flat £80 a month for a balance of £2,000.

This £80-a-month repayment would pay off the same £2,000 balance shown above in just 32 months (two years and eight months), with interest totalling £525. That's a saving of £2,185 from one tiny change.

In summary, what would you prefer? A debt lasting nearly 24 years, or one which is dead by mid-2014? Please make this move today, as you have nothing to lose but your debts!

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