A practical approach to credit card debt

Calculating debt

One of the more positive things about credit cards is that they're more flexible than loans. One of the negatives is that you pay more interest on credit card debt than you would on a loan. If you take a practical approach however, it is possible to keep your costs low. Below are some of the areas you should give extra attention.

Different rates for each type of action

Many card users will know what their typical APR is but that doesn't make it obvious as to how much interest they're paying; the interest is calculated depending on what you used the card for:

If you look through your credit card statement, you may find that there are different categories to your debt i.e. card purchases, balance transfer, cheque/money transfer, cash, etc. Each of these has a different interest rate, for example your monthly rate might be broken down as the following:

- Card purchases: 1.385%
- Balance transfer: 1.527%
- Money transfer: 1.667%
- Cash withdrawal: 2.075%

This means that if most or all of your debt is a result of card purchases, you pay less than if you had most of your debt as a result of money transfers.

Last in fast out

Credit card debt is a bit like moving plates with the use of a box; the last plate to be put in the box will be the fast to be taken out. Likewise, the last item to be added to your credit card balance will be the first to be deducted when you make a payment.
This is the traditional method, some card providers may use a different method, it's important to check just to make sure the method they use doesn't put you at a disadvantage.

If your credit card provider uses this method, it can help you to plan your payments. You will also know when to take advantage of the interest free period that's available on most credit cards.

A pound goes a long way

A majority of people who pay just the minimum payment on their credit card can afford to pay a bit more but don't do so because it doesn't seem like a small amount above the minimum payment makes a difference.
To show that even a small amount is of benefit in the long term, we'll use the scenario below as an example:

Jack and Jane have the same amount of debt on their credit cards and they pay the same monthly interest of 1.5%. They usually pay the minimum payment, but they've both realised they have an extra £5 every month that they could pay towards their debt.

Jack thinks the £5 is too small to make a meaningful difference to his credit card debt, so he waits for it to accumulate. After 10 months of accumulation, Jack now has £50 which he thinks is significant, so he pays it into his credit card debt.

Jane also thinks the £5 is small but knows that it will make a difference, so she pays the extra £5 every month on top of her minimum payment. After 10 months Jane has also paid £50 into her credit card debt.

So that's the difference?
When Jane paid that extra £5 in the first month, her interest charges for future months went down by an extra 7.5p, after the second month it went down by 15p, third month 22.5p and this pattern continued for as long as she paid that extra £5 each month. At the end of the 10 months she would've saved £3.37p in interest charges.

As Jack did not make any extra payments until the tenth month, he did not make the extra savings. In other words, Jack paid 7.5p more than Jane after the first month, 15p after the second, 22.5p after the third and so forth.

This shows you that every bit extra that you pay makes a difference however small. It also shows that the sooner you pay it the better in terms of long term savings.
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Dealing with an interest rate raise

It is not often that you sign an agreement and then see the terms of the agreement change along the way, but this scenario happens with credit card agreements. Many people receive letters from their credit card issuer notifying them of an impending change to the terms, which usually includes an increase in the interest rate and it doesn't just apply to new debt, it will also apply to debt you have already accumulated on the card. Balance transfer debt may be excluded depending on the deal agreed upon.

Likely cause

The most likely cause of an interest rate increase is a change in your credit rating; credit reference agencies regularly update the credit ratings of people they have in their databases. If your credit rating goes down, your credit card provider might decide that you have become riskier than before, therefore they try to negate this by adjusting your interest rate.

What you can do

The stated reason above isn't the only possible reason for an interest rate raise, the only way to be sure is to call your card provider and ask why your interest rate went up. If they say it's a result of a drop in your credit rating, it might be worth your time to check your credit files with the credit reference agencies; this will not only allow you to confirm whether your credit rating really went down, it will also show you why and help you decide what to do next.

Negotiate
If the drop is small and you have been a good customer, you might be able to convince the credit card issuer to reverse the decision to raise your interest or make the rise smaller; sometimes a card provider will compromise to avoid losing a valuable customer.

Opting out
If negotiating doesn't work and you're unwilling to pay the new interest rate, you can opt out of the new terms:

When your card provider sends you the letter notifying you of an impending change to your interest rate, it will also tell you that you can opt out and give you instructions as to how.

If you choose to opt out, what normally happens is the account is frozen; the interest rate remains the same on existing balance but you're unable to use your card for new purchases or anything else. After the balance has been paid off the account would be closed.

Temporary freeze
Opting out means you can't use your card anymore, but what if you want to keep your card for future use? You can make the freeze temporary by opting out now, and re-activating the card once the debt is paid down significantly:

Normally you have the option to re-activate your account at a future date if you change your mind about having the account closed (if the letter doesn't mention this, call and ask whether it's possible).

If this option is available to you, have the account frozen, this way you keep paying off your balance at the lower interest rate. Just before the balance has cleared, call the card issuer and ask to have the account re-activated.

It's worth remembering that after the card is re-activated the new interest rate will apply to remaining and future balance on the account.

If it’s not possible to re-activate the account after opting out of the interest rate rise, you’ll need to think carefully before opting to close the account; the closure will hurt your credit rating further, which means if you apply for a credit card elsewhere your interest rate may be even higher than the one you’re being offered.