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FEATURE: Plastic power

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How do credit cards work, and how can you get the most out of yours? Kate O’Raghallaigh takes a look.

UK consumers spent a total of £13.3bn on credit cards in December 2007, according to the British Bankers’ Association (BBA). So why is plastic so powerful? For some people, credit cards are the first port of call whenever a purchase has to be made. For others, they are nothing more than a temporary saviour from surviving on beans and toast in the week leading up to pay day. Credit cards have many benefits, however the degree to which they actually benefit your finances, really depends on how you manage your money.

A credit card allows you to borrow money for any purchases you make with the card until your billing date, by which you have to repay a minimum amount of what you’ve spent. If you pay your bill in full and on time every month, you will be the perfect credit card holder, but you won’t make the bank any money. Why? Because credit card companies make money from people who take advantage of not being required to pay back their debt in full each month. If you pay in full before the grace period – the period of time after your billing date in which you can pay – is over, then you won’t be charged any interest. If you don’t pay your bill off in full by the end of the grace period, you are charged interest on the amount you carry over to your next bill. The interest rate you are charged on your outstanding bill varies between credit card providers. At the time of writing, a typical APR was somewhere in the region of 10% to 17%. If you’re the kind of person who is likely to take one too many credit card-fuelled shopping sprees every month, a credit card might not be the most sensible idea.

Choices, choices

Tom Allder, vice president of UK lending at American Express, says: “Before choosing a credit card, it’s important to determine what benefits you are looking to receive. If you’re one of almost 20 million UK consumers using an unrewarding credit card, then a cashback credit card could be the way to go. These cards are great for rewarding customers for their spending.” Cashback credit cards are suitable for people who pay their bill in full every month, as the provider awards a percentage rebate of the value of purchases made on the card. If you’re someone who is likely to let your payments slide from month to month, then you probably won’t benefit from this kind of card.

Some credit cards also offer handy features such as domestic warranty cover, which protects electrical items bought with the card for anything up to a year after their store warranty expires, and purchase protection, which covers certain purchases you buy with your card if they are subject to accident, theft or damage. Furthermore, according to the Consumer Credit Act, credit card holders who purchase an item that is faulty or misrepresented can claim a refund from their credit card company. The item must have cost between £100 and £30,000. For more information, click here.

Esther James, financial researcher at comparison site Moneyfacts, says purchase protection is a popular feature on credit cards: “Of the 57 credit card providers that we list, 24 of those offer free purchase protection on some or all of their cards. Looking at a handful of those, the offers range from between 30 to 100 days of protection for goods purchased with the cards (some are protected in transit only). In most cases the cover will only pay out if any other existing insurance policies/warranties do not cover the damage or do not cover the full amount.”

Musical cards

In recent years, credit card companies have fought for people’s custom by offering low interest rates on balance transfers. For example, if you have spent £500 on your credit card and are charged an interest rate of 12%, you can transfer that balance to a new credit card and pay 0% interest on it for a specified period of time. Some providers even offer 0% interest on any purchases you make. You should always make sure you know what the grace period for new purchases is, however, as it is likely to be shorter than the period you get for balance transfers. Also, bear in mind that some cards may charge a balance transfer fee of approximately 2% or 3%.

The practice of transferring debt from one credit card to another has resulted in a culture of ‘rate tarts’, or people who constantly switch their credit card provider as soon as the generous 0% interest period is over. According to price comparison site MoneyExpert, 5.9m people switched their credit cards in the last six months in an attempt to get their debts under control with low rates on balance transfers.

Sean Gardner, chief executive of MoneyExpert, says that while the facility to switch cards is a good thing for those looking to repay their debt easily, it should not be overused by people looking for cheap money. He explains: “Credit card companies still offer lengthy 0% deals, some as long as 15 months. The worry is that consumers will see these deals as a chance to service debt rather than repay debt. That is a precarious situation as sitting on debt often leads to spending more elsewhere.”

Snare a good deal For those of you in search of a little plastic power to book the odd holiday or make an important purchase that you’d like extra protection for, a credit card is certainly worth considering. However, taking on the facility to spend money that isn’t yours is not something to be taken lightly, but if you work hard to manage your finances, you could reap the benefits.

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