More than 65% of Brits own a credit card, yet many are paying unnecessary interest because they do not clear their balance in full each month, according to financial education specialists.
The interest-free trap
Antonia Medlicott, founder and managing director of financial education company Investing Insiders, said the biggest misunderstanding is how credit card interest is applied. She explained: "All credit cards come with a period of interest-free spending, usually sitting at around 56 days. No matter the spend on your card, as long as you pay the full amount off on the due date, you'll have no interest to pay."
"In essence, you've had a short-term, interest-free loan. However, the emphasis here is on the word 'full'. Miss even one penny from your bill, and that interest-free benefit disappears."
Daily interest accrual
Rather than being added at the end of the month, interest starts building from the day each purchase is made if the balance is not cleared in full. "The way in which credit card interest works is that it begins to accrue daily from the date of each transaction," Antonia said. "This interest is waived if you pay your balance in full, but anything less than that, and you'll be charged interest for the whole period, as if you hadn't paid anything off at all."
Even paying off the remaining balance the following month may not stop extra charges appearing. She added: "If you don't pay your balance in full, but then pay it off completely in the following month, you may think you'd be in the clear. However, you will still see an interest charge on your next statement. This is due to trailing interest, with the only way to fully clear it being to pay off your balance for two consecutive months."
Minimum payment danger
Many people choose to make only the minimum payment shown on their monthly statement. While this keeps the account up to date, it can dramatically increase both the length of time it takes to clear the debt and the total amount repaid. Antonia said: "Whenever you get your credit card statement through, it always shows a minimum balance that you need to pay. This is calculated by taking your interest charges plus around one per cent of your balance. Whilst it aims to protect you from accruing mountains of interest, it's a long way from helping you to get out of debt."
She said someone with a £3,500 balance on a card charging around 23% APR could take more than 25 years to pay it off if they only make the minimum payment each month. Over that time, they could pay more than £4,000 in interest alone.
How to avoid unnecessary charges
To avoid unnecessary charges, Antonia recommends setting up a direct debit to pay the full statement balance every month where possible. If that is not affordable, she says paying more than the minimum and avoiding new spending on the card until the debt is reduced can help limit interest costs. For those already paying high rates, she also suggested looking at a 0% balance transfer card, which can allow borrowers to move existing debt interest-free for a fixed period, although these usually come with a one-off transfer fee. She added that expensive credit card debt should generally be cleared before putting money into savings accounts paying a lower rate of interest.
