Will Your Debt Last Decades?
A modest credit-card debt can last thirty years if you don't play your cards right. Is your plastic on our new 'danger' list?
Here in the UK, there are around 48 million adults who, between them, have 75 million credit cards and charge cards. However, one adult in three has no credit card, so there are only about 30.6 million credit-card users in Britain. Thus, a typical cardholder has an average of 2½ credit cards.
What's more, according to the latest figures from the Bank of England, we owe £55 billion on our `flexible friends'. Around three-quarters (75%) of this debt is interest-bearing, with the average yearly interest rate being 16.5% APR. Therefore, credit-hungry cardholders are paying nearly £7 billion a year in interest. Ouch!
The menace of minimum monthly repayments (MMRs)
How long does it take to repay an outstanding balance on a credit card? The settlement period depends on two things: the interest rate charged and the level of repayments made. The higher the interest rate, the longer a debt will take to repay. Likewise, the lower the repayments, the longer a debt lingers.
In the early Nineties, all credit cards had a minimum monthly repayment of at least a tenth (10%) of the outstanding balance. In other words, with a debt of £2,000, a card issuer will expect you to repay at least £200 a month. However, greedy lenders realised that lower minimum monthly repayments would hugely boost their profits. Hence, since the mid-Nineties, MMRs have tumbled.
Today, with precious few exceptions, all credit cards require a minimum monthly repayment of between 2% and 3% of the amount owed. Alas, thanks to such low MMRs, a modest debt of, say, £2,000 can take decades to repay...
MMRs: the bad, the ugly and the downright dangerous
The Fool often classifies financial products into three categories: the good, the bad and the ugly. However, when it comes to MMRs, there are no `good' cards. Nevertheless, I've sorted 56 different credit-card brands into three groups, using data from the June issue of Moneyfacts magazine:
1. The bad (MMRs greater than 3%)
Card issuer | MMR (%) |
|---|---|
Capital One Classic | 5.00 |
Coutts | 5.00 |
First Trust Bank (NI) Option 3 | 5.00 |
Vanquis Bank | 5.00 |
As you can see, there are just four cards in this category. One comes from upper-class bank Coutts; the remainder are `beginner' credit cards aimed at borrowers with no -- or imperfect -- credit histories.
2. The ugly (MMRs of 2.5% to 3%)
Card issuer | MMR (%) |
|---|---|
American Express | 2.50 |
Bank of Ireland (UK) | 2.50 |
BMW | 2.50 |
British Airways Amex | 2.50 |
Marks & Spencer Money | 2.50 |
Post Office | 2.50 |
Sky | 2.50 |
Alliance & Leicester | 3.00 |
ASDA | 3.00 |
Bank of Cyprus | 3.00 |
Barclaycard Initial | 3.00 |
Capital One | 3.00 |
Cheshire BS | 3.00 |
Clydesdale Bank | 3.00 |
First Direct | 3.00 |
First Trust Bank (NI) | 3.00 |
HSBC | 3.00 |
John Lewis/Waitrose | 3.00 |
MBNA Europe Bank | 3.00 |
Morrisons | 3.00 |
Nationwide BS | 3.00 |
Northern Bank (NI) | 3.00 |
Paypal | 3.00 |
SAGA | 3.00 |
Sony | 3.00 |
Tesco Personal Finance | 3.00 |
Ulster Bank (NI) | 3.00 |
Virgin Money | 3.00 |
Yorkshire Bank | 3.00 |
Seven card issuers charge an MMR of 2.5%, with a further 22 charging 3%. In my view, these MMRs are dangerously low and could easily condemn unwary cardholders to a lifetime of debt.
3. The downright dangerous (MMRs of 2% to 2.25%)
Card issuer | MMR (%) |
|---|---|
AA | 2.00 |
Amazon | 2.00 |
Bank of Scotland | 2.00 |
Britannia BS | 2.00 |
Egg | 2.00 |
GM Card | 2.00 |
Halifax | 2.00 |
Hilton HHonors | 2.00 |
Intelligent Finance | 2.00 |
Leeds BS | 2.00 |
Lloyds TSB | 2.00 |
Marriott | 2.00 |
Orange marbles | 2.00 |
Smile | 2.00 |
The Co-operative Bank | 2.00 |
Yorkshire BS | 2.00 |
Abbey | 2.25 |
Barclaycard | 2.25 |
Citi | 2.25 |
MINT | 2.25 |
NatWest | 2.25 |
Royal Bank of Scotland | 2.25 |
Sainsbury's Bank | 2.25 |
Sixteen card issuers apply an insanely low minimum monthly repayment of 2%, with a further seven charging 2.25%. Frankly, with MMRs this small, these lenders are putting both themselves and their cardholders at massive risk.
Three years or three decades in debt?
Let me show you what I mean, using the following worked example:
Balance of £2,000
Interest rate of 16.5% APR (the average for UK-issued cards)
Minimum monthly repayment of 2% (minimum £5)
Plugging these numbers into my specially designed credit-card engine/spreadsheet shows that the above balance will take 369 months to repay. That's thirty years and nine months. What's more, over this period, your interest bill comes to £3,268.40, so the total repaid is a staggering £5,268.40.
In summary, if you get into the habit of paying minimum monthly repayments on your credit card, then you can look forward to spending most of your adult life in debt. Instead of paying MMRs, set up a direct debit or standing order for, say, a flat (fixed) 4% of your debt. Doing this will clear your balance in three years instead of three decades!
More: Find classy credit cards via the Fool | Cut Your Interest Payments Down To Zero | Four Top Credit Cards
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