How 0% credit cards cost you money

Credit cards can appear to be totally free, but most people still end up paying for them...

All credit cards offer you the opportunity to make purchases interest free for more than a month. Pay the debt back on time and it should cost you nothing. Some cards also extend totally free borrowing on purchases through introductory 0% offers of 12 months or more.

Yet despite this the credit-card industry is one of the most profitable in the UK. This is due to excellent marketing tactics and extremely loose lending regulations that allow card providers to catch us out in all sorts of ways. With more than 60 million credit cards in circulation right now, there are a lot of opportunities for lenders to profit from their use.

Above board profits

One way that the industry does this is by charging fees to shops each time a credit card is used. This ensures that the card provider makes a profit even if you never pay it a penny in interest, fees or fines. It's only if you use shops that charge you extra for paying by credit card that this will affect you directly.

Lenders also cross-sell products such as insurance and savings accounts to existing card customers, which is a perfectly legitimate way to make money from both good and bad customers. Charging annual fees for premium-card benefits is similarly above board, in my view.

When you're cross-sold products, always compare elsewhere before buying, because it's extremely unusual for lenders to offer competitive products to existing customers; it's just too easy to sell over-priced ones to such captive audiences.

If you pay annual fees, try to estimate how much benefit you personally get out of your card, because most people are better off with a free card and buying their other products separately.

Seedier tactics

From legitimate marketing and revenue-building tactics, we now move on to just some of the more underhand ways that 0% cards make serious money for lenders.

Staggering interest rates

70% of existing cards had outstanding balances just after Christmas in 2009, according to the British Banking Association. It's hard to believe that most people intended to pay them off the following January, or that most of them were using 0% deals, especially with the average card balance being in the thousands of pounds. (And remember that on average we have more than one active credit card each, and several per household.)

Lenders will usually charge shockingly high interest rates of 16% to 20% on these debts. If you average £500 on your credit card over five years, you can expect to have paid about £500 in interest over the period. Think about it.

You might think that it's ok for the industry to charge such high interest rates for the extra risk they take on when they grant unsecured loans through credit cards. However, even during the past few years when debt problems have really come to a head, the industry is sitting very comfortably.

In any case, lenders can very easily convert unsecured debts into secured ones with a simple court application, and they often are. Read more in Will you be forced to sell your home to repay a £600 debt?

Many deals aren't free

If you move your debts around each year from balance-transfer card to balance-transfer card, it's much, much cheaper than paying interest. However, it still costs you a fair bit.

Related how-to guide

Pay off your credit card debts

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Let's say you have a £5,000 debt. You repay a bare minimum of 2% for three years before getting your act a little more together to repay a fixed sum in excess of £100 to clear the remaining balance over two years. With a 3% fee each year, that still adds up to £500 in fees over the five years.

If you instead paid a fixed amount of £200 per month on the £5,000, you'd pay just £250 in fees and clear the debt in just over two years. Hey presto, you're £250 richer instead of the bank, and your finances have quickly become much more secure from the various financial emergencies we all experience from time to time.

Using your card for many purposes

It doesn't matter if you have a 0% deal or if you pay off your bill each month: if you withdraw cash from a cash machine, you will immediately pay fees and interest from day one, with no interest-free grace period. That's the way it works. What's more, the interest charged is massive.

Withdraw £200 a month in this way and pay it back just ten days later, and you can expect to have paid £75 to £90 in fees and interest over the year. Just don't do it.

Remember that 0% or other introductory deals are for specific types of borrowing only. The card might offer you 0% when you transfer a debt from another card to it, but it will charge you interest on purchases, for example. Or vice versa.

Despite recent industry-wide changes to make things better for consumers, some card providers will still let more expensive types of debt sit on your card for longer by forcing you to repay cheaper 0% deals before debts costing interest. Read more about it in Credit cards that bend the rules.

Not paying enough each month

If you average a £500 balance over five years and you miss a couple of payments per year, you can expect to have paid £120 in fines. That's in addition to the £500 or so interest that I mentioned earlier.

Plus when you miss a single payment you lose any 0% deals you were getting on the card, and it can give you a stinking credit record, making borrowing even harder and more expensive in future.

Watch out for lenders moving statement and payment dates, which can cause you to miss payments. Also, if you slip up just once in a while it's worth calling the lender, as they will often reimburse the fees or reinstate 0% deals.

More: Compare credit cards | Pay 0% on new credit card for 18 months | Credit cards that bend the rules