Watch Out For The 0.1% Trick!

Most traditional current accounts pay yearly interest of just 0.1% on credit balances. Bizarrely, so do several Best Buys, as our research reveals.

Almost nine in ten adults (90%) have a current account, making it one of the most widely held financial products in the UK.

The bad news is that the majority of us have an account with one of the `Big Four' -- Barclays, HSBC, Lloyds TSB and NatWest. These big banks have had a virtual monopoly on British banking for decades, thanks to their size and scale. However, over the past ten years, they have lost some ground to new entrants such as Abbey, Alliance & Leicester, Cahoot, Halifax/Bank of Scotland, Nationwide BS and Smile.

There are three key problems with having an old-style current account:

• 1.    You get a pathetically low rate of interest on credit balances. Although banks lend our money to each other at a rate of around 6.3% a year, most current accounts pay interest of just 0.1% a year before tax. In other words, we're giving away our money incredibly cheaply to banks. Indeed, they make hundreds of million of pounds a year from this `float' of cut-price money. You can learn more about this rip-off in Britain's Worst Bank Accounts.
  
  
• 2.    On the other hand, the rates of interest charged on overdrafts are incredibly high, especially for unauthorised borrowing. As I warned in The Great Overdraft Sting, annual interest rates for unapproved overdrafts can approach 40% a year. Ouch!
  
  
• 3.    To add insult to injury, the big banks make billions of pounds a year from penalty charges relating to unauthorised overdrafts. It is criminal that banks get away with charging as much as £39 a time for rejecting a payment of as little as £1. For more information on this scandal, read Bank Charges: Lloyds TSB Gets Sneaky.

Of course, the simple solution to these problems is to ditch your outdated bank account in favour of the new generation of all-singing, all-dancing current accounts. Switching is easier than you might think: according to consumer champion Which?, more than three-quarters (76%) of switchers found the process easy.

However, merely switching to a Best Buy current account won't necessarily leave you sitting pretty, as several of these accounts still apply the `0.1% trick' described above. In fact, it's essential for you to read beyond the headline-grabbing interest rates in order to discover exactly what you're getting for your money. Let me show you what I mean, using the following table-topping current accounts:

Best Buy current accounts for credit interest

Source: Fool.co.uk's unbiased, independent search engine

As you can see, all of the above Best Buy current accounts pay headline interest rates of more than 6% a year before tax. However, these market-beating rates are only paid on credit balances up to £2,500. For all amounts in excess of this threshold, the rate plunges to 0.1% (2.50% for the Abbey account). Note that each of these accounts require monthly funding of £1,000, apart from the Alliance & Leicester Premier Direct account, which demands £500 a month.

The Coventry First account is the important exception to this rule, as it pays 6.35% AER on balances up to £250,000. Thanks to its generous interest rate on larger balances, this current account is the clear winner for customers who often run a balance of more than £2,500. Indeed, as you can see from the final column of the table, the Coventry First account pays almost three times as much credit interest on an average balance of £7,500 as does the Halifax High Interest Current Account!

Therefore, if you sometimes build up a large balance in your current account, then it pays to take a long, hard look at the interest rate paid on sums over £2,500 before switching. Otherwise, a big slice of your money could be earning almost no interest at all. Also, given that the Coventry BS First account pays such a high rate of interest, I may even consider moving some of my savings to it, too!

Finally, if your balance rarely rises above £2,500, then my pick of the four remaining accounts is the popular and award-winning Alliance & Leicester Premier Direct account. As always, the choice is yours!

More: Choose a cracking current account today | First Direct Scraps Credit Interest | Get More Dosh From Your Current Account