Faced with rising levels of bad debts and falling fines, credit-card companies have come up with these sneaky traps.
When is interest-free credit not interest free? When you're forced to pay fees (and, amazingly, even interest) for the privilege of borrowing money at 0% for an extended period!
Millions of borrowers have made use of 0% balance transfers since they were introduced by online bank Egg on Christmas Day, 2000. By transferring your existing credit-card debts to a 0% credit card, you can enjoy a break from interest lasting up to a year. Naturally, British borrowers would much rather pay no interest than the annual rate of 16% charged by a typical credit card, so the balance-transfer market is booming.
However, 0% balance transfers are 'loss leaders', so credit-card issuers are always on the lookout for ways to offset these lending losses. The most popular option is to charge a handling fee for balance transfers, typically 2% to 3% of the value of each transfer. At first, these fees were capped at a maximum of, say, £50, but many lenders now levy uncapped transfer fees.
Of course, it's important for borrowers to take these transfer fees into account, because they vary from card to card. Today, I spotted some interesting research carried out by Marks & Spencer Money (now owned by HSBC bank) into transfer fees.
M&S Money's report warns cardholders to look beyond the 0% interest rates and check the true costs of balance transfers. It found that, in some cases, 'switchers' (people making use of 0% deals) could be worse off than if they kept the debt on their existing card!
It's important to understand that a balance-transfer fee is an upfront charge which is based on the balance being transferred. Of course, your balance reduces over time thanks to your repayments, so this upfront charge has a much bigger impact than you'd imagine.
The following table shows how transfer fees compare when converted into annual equivalent interest rates, which are comparable to the interest rates charged by credit cards:
Balance transfer fees expressed as annual equivalent interest rates (AERs)
(based on a transfer of £1,000 which is fully repaid in equal instalments by the end of the 0% deal)
Interest-free period | Fee of 2% | Fee of 2.5% | Fee of 3% | Fee of 4% |
Six months | 7.0% AER | 8.9% AER | 10.7% AER | 14.5% AER |
Nine months | 4.9% AER | 6.1% AER | 7.4% AER | 9.9% AER |
One year | 3.7% AER | 4.7% AER | 5.6% AER | 7.6% AER |
Source: M&S Money
As you can see, paying an uncapped transfer fee of 3% for a 0% deal lasting six months is the same as paying 10.7% AER -- and several credit cards charge standard interest rates lower than this. Naturally, the longer you take to repay your balance, the less of an impact any transfer fee has, and vice versa.
The advice from M&S Money -- and me -- is simple: look for a card which doesn't charge fees on transferred balances. For example, M&S Money's &More card charges 0% for a year on purchases, with a fee-free lifetime rate of 3.9% a year on balance transfers. This makes it a Best Buy for low-rate lifetime transfers (and for new spending), as I confirmed yesterday.
On a separate note, I continue to get emails from Fool readers who complain that some card issuers treat balance-transfer fees as retail purchases, notably Egg and MBNA. This means that although the transferred balance is itself free of interest, the transfer fee attracts interest at the full standard rate, which is usually 16% a year or more. Of course, a £2,000 balance transfer with a fee of 2.5% would generate a transfer fee of £50, which would incur interest of just 62p a month at a monthly interest rate of 1.245% (16% APR). This is a small price to pay for a decent balance-transfer deal, but it's the principle of the matter!
In my view, card issuers offering 0% on balance transfers that charge standard interest rates on the associated handling fees may be in breach of the rules governing the advertising of credit, known as the Consumer Credit (Advertisements) Regulations. After all, one can't get the 0% deal without paying the fee and one must then pay interest on the fee. Thus, the transfer itself is, in effect, subject to an interest charge, so it should not be advertised as a 0% deal!
Therefore, if your credit-card issuer starts charging interest on a balance-transfer fee, ask it to point out its right to do this in its terms and conditions. If you're unhappy with the company's reply, you can complain to the Bank, the Financial Ombudsman Service, or the Office of Fair trading, which monitors credit advertisements.
More: Want cheaper credit? Compare cracking credit cards and super personal loans via the Fool!