The £500m Credit-Card Rip-off

Card firms make £500 million a year thanks to this sneaky trick, so make sure that you don't fall for it!

According to the Nationwide BS, credit-card issuers pocket an extra £500 million a year by manipulating the order in which we repay our plastic debts.

Next week, Nationwide launches a television campaign which urges borrowers to abandon credit-card firms which use our monthly repayments to repay our cheapest debts first, leaving us paying high rates of interest on our remaining balances.

Almost all UK card firms allocate our monthly repayments first to outstanding balances with the lowest rates of interest, such as 0% balance transfers. Meanwhile, the remaining balances, such as purchases and cash advances, continue to accrue interest at sky-high rates of between 15% and 30% a year. Ouch!

Nationwide is the only major credit-card issuer not to employ this sneaky scam, which is known as a negative payment hierarchy, as all of its credit cards apply repayments to the most expensive debts first.

Although applying a positive payment hierarchy may not sound like much, the savings can really stack up. In the example below, over the course of a year, a Nationwide cardholder's interest bill would be £100 less than that paid by other cardholders, purely thanks to Nationwide's fair payment hierarchy:

• Mr Plastic transfers £3,000 of his existing credit-card debt to a 0% for nine months balance-transfer deal.
• He spends £300 a month on his card and withdraws £40 a month in cash (which is very naughty, as only debit cards should be used for withdrawing cash!).
• Mr Plastic makes monthly repayments of £400.

(This calculation assumes the following: all spending and cash withdrawals take place on the first day of each month; monthly repayments are made on the last day of the month; the standard rate for purchases and balance transfers is 15.9% APR; the rate for cash advances is 20.9% APR; and the typical 2% balance-transfer fee has not been taken into account.)

Sadly, although almost three in five cardholders (59%) believe that it is important to use a credit card which applies a positive payment hierarchy, very few of us actually know how our repayments are applied to our balances. Furthermore, the payment hierarchy is not stated in the Summary Box which all card providers must display, so it's hidden away from view. Boo, hiss!

Hence, many customers who are attracted to cards with ultra-low (even 0%) introductory rates often don't benefit fully from these deals, because they are conned by negative payment hierarchies. In many cases, these are the more vulnerable and financially unsophisticated customers, particularly those who frequently use their credit cards to withdraw cash, thus incurring ultra-high interest rates and withdrawal fees.

Alas, until the day when regulators force credit-card lenders to use positive payment hierarchies (don't hold your breath!), you need to keep your wits about you. The best way to avoid this rip-off is to use the right card for different needs, such as:

• Finding a great 0% on balance transfers card, which you NEVER use for spending or cash withdrawals;
• Using a Best Buy 0% on purchases card, which you NEVER use for balance transfers or cash withdrawals; and
• NEVER using your credit cards for cash withdrawals, because that's what debit cards are for. If you really must use a credit card to withdraw cash, the Clear card from the Co-operative Bank charges a low standard rate of just 9.9% APR, with no fees for the UK cash withdrawals.

So, play your cards right and you need never have to worry about negative payment hierarchies ever again! In the meantime, complain to your card providers about their negative payment hierarchy and maybe, if enough of us do so, they will change their policy!

More:Compare credit cards at The Motley Fool.