An article was recently released on the BBC Business website:
“Will 0% interest credit card deals lure many into debt” (BBC)
The answer is clearly “Yes”. Credit card companies generate revenue from their customers being in debt. Therefore, they wouldn’t be offering this card if it didn’t lure people into debt.
However, if you can learn how to manage a 0% interest credit card, you don’t have to become one of these people. This is one area where you can actually “beat the bank”!
What are 0% interest credit cards?
You would think that the clue is in the name: they are credit cards which charge 0% interest. However, in reality, there are actually a number of different types of 0% interest credit cards, and they vary quite significantly.
- Balance transfer – this card allows you to transfer existing debt (from store cards, credit cards, car loans, etc) onto a new credit card which charges 0% interest for a pre-agreed length of time.
However, a “fee” is charged when transferring the debt. For example, current offers with Barclaycard are available:
1) 34 months interest free for a fee of 2.99% of the balance transferred
2) 24 months interest free for a fee of 1.25% of the balance transferred
On occasion, the fee charged will also be 0% (for example with the Tesco Bank Clubcard Credit Card), but the interest free period will usually be smaller (12 months or less).
- Purchase – 0% purchase credit cards are the true 0% option. As long as the balance is paid down within the pre-agreed 0% period (which can extend up to 20 months), then any purchases made on the credit card will not be charged any interest in that period. These don’t usually come with a fee (but it’s always good to check the terms and conditions).
- Money transfer – an often overlooked option, the money transfer credit card allows you to transfer money to your current account at an interest rate of 0% over a pre-agreed period. However, as with balance transfers, this incurs a fee when transferring the money. For example, the MBNA credit card currently offers:
- 32 months interest free for a 2.69% fee of the money transferred
- 21 months interest free for a 1.50% fee of the money transferred
Some examples of using these cards well
Many people, including the article above, warn of the dangers of these cards. However, if well understood and with a well-defined plan, they can be one of the most powerful weapons in your financial armoury.
Let’s show 3 examples (one for each card, which are very different in nature) where these cards are being used well:
Example 1 – Balance transfer
Scenario: John currently has £8,000 in credit card debt, paying 24.9% APR, and only making minimum payments of 1% of his outstanding balance each month. He’s previously been oblivious to the damage this was having on his financial future, but has recently signed up to the 2015 Moneystepper Savings Challenge and realised the effect this is having!
He decides that over the course of the next 2 years, he can afford £340 per month in repayments each month if he concentrates on his personal finances.
If he doesn’t change at all: Over the next 24 months, John will have made repayments totalling £2,160, and his balance on his credit card would have actually increased to £9,805. Therefore, in total, his “costs” are £11,965.
If he only changes his attitude: In this case, he will make £340 per month in repayments, but still remain with the same credit card (24.9% APR). In this case, he will make £8,160 in repayments, and his balance on his credit card would remain at £2,299. Therefore, in total, his “costs” are £10,459.
If he changes his attitude and moves to a 0% credit card: Here, John makes a plan! He signs up to the 0% balance transfer card above for 24 months with a 1.25% fee. He determines via his plan that if he makes monthly repayments of £337.50, it will repay the total debt and fee before the end of the 0% period. In this case, he will make repayments of £8,100, and his balance on his credit card would be £0. Therefore, in total, his “costs” are £8,100.
So, by having a plan, John manages to save £3,865 in 2 years and has got rid of all his debt. Pretty cool, right?
Example 2 – Purchase
Scenario: Katie is about to buy a new car. So that we can make this easily comparable, she is going to buy a car (and PCP offer) that we have researched in a previous article to buy a brand new Nissan Note 1.2 Acenta 5-door for £10,499 in cash. Unfortunately, she doesn’t have this amount in cash right now and needs to “finance” the deal somehow (note: this is only an example and certainly not something we would recommend. If you cannot afford to buy a new car, then buying second hand will always be financially better than buying new with finance).
The PCP deal is fairly complex (this is why its tricks so many people) but effectively the interest rate is effectively 8.8% APR (see related article for calculations).
If he doesn’t change at all: Over the next 4 years with the PCP deal, Katie will have repaid £12,866.
If she uses a 0% purchase card: Katie makes a plan! She can afford to use a 0% purchase credit card and repay the £10,499 over the interest-free period of 20 months (£525 per month). This keeps her amount paid as £10,499, and a saving of £2,267.
Example 3 – Money transfer
Scenario: Graham (yes, me, because I do personally adopt this approach) is secure financially, but is looking for further ways to maximise any possible returns. He sees the MBNA 0% money transfer credit card over 32 months and smells an opportunity!! J
If he changes nothing: £0. He’ll have no debt, and no income from this “debt”. He does nothing, so his comparison is £0.
If he plays it safe: After applying for the card, he is granted a credit limit of £10,000. He transfers this cash to his current account and is charged the 2.69% fee (£269). He uses a Santander 123 current account that pays 3% (2.4% after basis-rate tax) up to £20,000. Therefore, he decides to leave it in the current account so that he can pay off the credit time at any point if needed. After 2 years, the cash (after-tax) in the current account will be worth £10,653. After paying down the £10,000 debt and £269 fee which was added to the debt, then he would have earned £384.
If he plays it less safe: In scenario 2 (and what I actually do) he decides to invest the cash into the markets in a stocks and shares ISA. If we assume an 8% annual return from investments in the stock markets, then the investment would be worth (on average) £12,278. In this riskier situation, he earns an average of £2,009 in the period.
BE CAREFUL: This is a method which clearly carries a high degree of risk. The “on average” is bolded above as the average will never occur because of the nature and high volatility of the markets. However, it can be plausible if you are in the following situation and have the following plans in place:
- You have very good credit. The key with “stoozing” in the markets is to make it as long-term as possible in order to decrease the impact of variance. IF you have a good credit score, you can usually perform a 0% balance transfer just before the end of the periods and therefore never have to touch your investments.
- Be financially prepared. Say you took out this deal on July 6th 2006 when the FTSE 100 was at 5888.90. 32 months later, you would need to resolve the credit card before it began incurring interest. If you couldn’t find a new credit card to transfer the balance, you will need to liquidate your investments to repay the £10,269. However, the FTSE 100 on Mar 6th 2009 (32 months later) was at 3530.73. This means that your £10,000 investment (ignoring dividends) is only worth £5,995 and hence you would need to find the difference yourself to pay down the debt.
- That is the worst case scenario over the past few years. I personally am happy with this risk as I could fund this from my own savings in the worst case scenario. This is because of the risk vs reward in this situation. This will be different to everyone’s personal situation and their risk tolerance.
- We’ve looked at the worst-case, and average, but what about the best-case? Say we took the card out on March 6th 2009, when the FTSE 100 was at 3530.73. 32 months later the FTSE 100 was at 5865.85. With assumed 3% dividends annually (reinvested), this means our £10,000 would be worth £17,735. Therefore, a fee of £269 led to a profit over this period of £7,735.
Rules to live by
Whatever 0% card you take out, and whether you use it to pay down debt, as a cheaper way to make new purchases or to “stooze”, there are certain rules you should always follow to make sure you avoid the 0% credit card traps:
- Make a plan! Before you take out the credit card, you should have your proposed repayment plan, together with the best and worst case scenarios.
- Always make at least the minimum payment each month – set up an auto direct debit to ensure that your payment is made on time.
- Always pay off your balance (or perform another balance transfer to another card) before the 0% period finishes. These cards usually charge very high interest rates after the 0% introduction period.
- Only use 0% credit cards if you FULLY understand how they work and you have read the terms and conditions thoroughly so you don’t get any nasty surprises.
- Never let the credit drive the purchase. This is a big one, and probably deserves its own section…
Key rule: never let the credit drive the purchase!
In my experience, this is the most common way that people mistreat 0% credit cards. Some people buy things that they simply don’t need because of the lure of 0% credit.
Even more common is the following situation. A young couple need a sofa for their new apartment. They go down to the store and they see a few sofas they like. They speak to the salesperson to discuss them.
The salesperson then says something along the lines of “You could take that sofa, you could take this better designed, better quality sofa. Yes, it’s more expensive, but at 0% finance over X months, it only works out at £Y per month”.
The couple concentrate only upon that £Y per month and decide that they can afford this amount and the purchase is made.
Little thought goes to the fact that the couple have just been convinced to buy a much more expensive sofa (more than they need or could afford) and they don’t have a plan for the repayments beyond the fact that “Yeah, I think we can afford that”.
This is the perfect example of letting the credit drive the purchase. Don’t let it!