Ditch The Interest On Your Debts

Laura Starkey looks at how to tackle your debts in the credit crunch.

This article has already been emailed to Fools as part of our Summer Lolly campaign.

Since the credit crunch began last Summer, financial institutions have been clinging on tight to their purse strings.

And as banks have become choosier about who they will lend to, the old free-flowing river of credit has reduced to something more like a steady trickle.

The result? Many people are having to reign in their borrowing on credit cards and loans.

Nevertheless, the amount we owe as a nation has continued to rise. According to debt charity Credit Action, by the end of June 2008 the average UK adult had £4,900 worth of unsecured debt -- up from £4,550 the previous year.

The question is, if Brits are borrowing less, how come our debts aren't diminishing?

A matter of interest

Yes -- you guessed it -- it's the mounting cost of interest that's making it difficult for people to make a dent in their debts.

Credit Action statistics show that the average interest rate on credit card lending is now 17.5% -- 12.5% above the Bank of England base rate, and 1.8% higher than it was two years ago.

Last month, Fool partner Moneyfacts reported that a raft of credit card rate increases had taken effect since this April. Among them were 19 purchase rate increases, 14 cash rate increases, 8 cash withdrawal fee increases and 5 balance transfer fee hikes.

At the same time, rates on overdrafts and personal loans have also crept up.

All this means that if your debts are interest-bearing, you could find they're more expensive to pay off this year.

Cutting the cost of credit

UK adults now have an average credit card limit of around £5,000, according to Credit Action.

Paying the average APR of 17.5% on a debt of this size seriously damages your chances of reducing it quickly -- and the longer a credit card balance takes to pay, the more expensive the process becomes.

However, moving your borrowing to a 0% balance transfer card  or lifetime balance transfer credit card could slash the amount of interest you're charged.

Look at the difference transferring your debt to one of these cards could make to your debt after just 12 months:

By shifting a balance of £5,000 to the market-leading Capital One Bank Platinum BT & Purchase MasterCard, you'd pay no interest for 15 months. If you simply kept your payments at the same level as you would have done on a bog-standard interest-bearing credit card, you will manage to pay off an additional £585 of debt -- and save a staggering £788 in interest charges over a year.

However, it's worth remembering that although this card offers the longest 0% balance transfer deal on the market, it won't last forever. After 1st December 2009, the APR will revert to 16.9% (typical) -- and at that point, you'll need to apply for a new balance transfer deal if you want to keep interest charges at bay.

Also, anyone with a less than perfect credit rating may find getting a 0% balance transfer deal from Capital One difficult.

So, if you're concerned you might be knocked back for the Capital One card, the best-buy lifetime balance transfer deal is a very worthy alternative.

The Barclaycard Platinum Long Term BT MasterCard/Visa offers borrowers a low interest rate of 6.5%, which will not increase until entire balance you've transferred to the card is paid off. The rate is just 1.5% above the Bank of England base rate, and significantly lower than even the best rates charged on personal loans at the moment.

By shifting a £5,000 debt to this card instead of leaving it on your usual piece of plastic that charges you 17.5%, you could save £498 in interest charges over a year -- and reduce your debt by an extra £463.

Don't forget your overdraft

If you've ditched the interest on your credit card debts, what about any overdraft you might have?

Some banks charge around 20% interest on overdrafts -- even if they're arranged -- which means letting your current account drift into the red on a regular (or permanent) basis could be very costly.

However, some credit cards -- such as the Virgin Money Credit Card MasterCard -- will allow customers to transfer money from the card into their bank accounts. Thus, you can shift your expensive overdraft onto your credit card, and cut your interest payments down to 0%.

Words of warning

If you handle balance transfer credit cards like these correctly, they should work like a charm. However, it's crucial to remember that spending on a balance transfer card can cancel out its magic.

Many lenders operate negative repayment hierarchy, so the purchases you make will be charged at a higher interest rate and paid off last. This means they'll `sit' on the card racking up interest, while you clear the balance that's at a lower rate.

Also, thanks to the credit crunch, it's worth pointing out there's no guarantee anyone will be accepted for the credit cards they apply for.

However, if you've got a good credit record, you shouldn't be put off applying.

This year, I've applied for one 0% and one lifetime balance transfer deal, and been accepted for both -- which will make a huge difference to my finances this year, and in years to come.

I hope my Fellow fools have similar luck, and can make similar savings. Good luck!

Compare credit cards at Fool.co.uk