CREDIT CARDS

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Credit card providers are making an extra £500m profit every year from the way they allocate the payments customers make to their accounts. Banks make the money by applying card payments to the cheapest debt first, usually balances that have been transferred in 0% deals. Balances at higher interest rates, such as purchases and cash advances, continue to accrue interest, the Nationwide building society warned. The building society estimates there are 10m credit card accounts where the cardholder has a spending pattern which means that this order of payments costs them more interest than necessary.

Nationwide and Saga are the only major credit card providers that apply payments to the most expensive debt first across all their credit cards. Nationwide executive director Stuart Bernau said, "This is a policy that enables the banks to make half a billion pounds of profit every year, or £50 per year for every credit cardholder affected. I don't believe that consumers really understand how they are charged interest on their credit cards. At a time when banks should be seeking to rebuild trust among consumers, this is exactly the sort of practice that undermines that trust."

When customer payments are applied to the cheapest debt (often 0% deals) it fails to reduce the amount they owe at a higher interest rate. For example - a credit card user makes a £3,000 balance transfer at a 0% interest rate. He then makes monthly purchases on the card of £300 and takes monthly cash advances of £100. At the end of the month the customer assumes that, if he repays £400, this will cover the purchases and cash advances and he will avoid being charged interest on these. However, what typically happens is that the payment is applied to the balance transfer, reducing that to £2,600, and at the same time higher rates of interest will be charged on the purchases and cash advances which remain outstanding and increase by £400 every month. (Source: Mail on Sunday)

A credit card with an annual percentage rate (APR) of 28.5%. That doesn't sound like Asda price. Yet the supermarket famed for chirpy jingles and good value is piloting this costly rate in 30 towns for customers judged a poor credit risk. But the headline rate for the new card, the one potential customers will see in promotional material, is not 28.5% but 13.9%, which isn't bad compared with the high-street lenders, though still three percentage points higher than the best. Asda is also offering 0% on balance transfers for an introductory period of six months.

Once the introductory offer ends, many Asda shoppers will qualify for the lower headline rate. But, as with other cards, you'll first have to jump through its credit-check hoops. The card, which is set to be rolled out nationally in 2005, is the latest to feature risk-based pricing. Instead of a lender rejecting someone because, say, they have a record of missed payments or a county court judgment against them, it will give them a credit card but charge a higher rate of interest to reflect the extra risk it is taking on.

Many banks use low headline or "typical" rates to tempt people to apply in the first place. Only when customers get their cards do they find they haven't qualified for the cheapest deal. Instead, they are being charged a much higher rate. Card providers are allowed to advertise the lowest rate on offer as long as 50% of customers actually get this. But this rate has the potential to be misleading, which is why proposals have been included in a Department of Trade and Industry White Paper on consumer credit to raise this figure to 66%.

At the moment, card firms can find themselves ranked high against the competition for their attractive offers even if half their customers aren't paying this rate. Halifax's One Visa card, for example, regularly tops the "best buy" tables with its 0% introductory offer for nine months on balances and transfers, before it reverts to a standard APR of just 9.9%. But if your credit reference is a bit shaky, you may end up with an APR of 18.9% instead. The same is true of Barclaycard, which has a standard APR of 14.9% and a far higher 24.9% for riskier customers.

Those who support risk-based pricing defend the practice by arguing that borrowers with bad track records can still get credit at a reasonable rate. Asda's 28.5% deal isn't cheap but the Vanquis credit card, backed by Provident Financial, charges up to 65%. However, critics argue that risk-based pricing undermines transparency and makes it impossible for people to compare rates accurately. While the Consumers' Association (CA) is cautiously in favour of the practice, it remains concerned that consumers struggle to understand the increasingly complex UK credit card market.

Some providers are even offering customers the chance to design their own plastic. Insurer More Th>n introduced a DIY credit card that lets users pick a mix of APR, fees and cashback to suit them. If you opt for a low APR, for example, you will face a higher annual fee. To make matters more confusing, what deal you actually get will depend both on your credit reference and where you go for the card. People with a poor record may be rejected by one lender only for another to welcome them with open arms and a juicy credit limit.

"Every company sets its own credit-scoring system," says Mike Naylor at the CA. "They might look at how often you've moved and the number of card applications, along with your salary, homeowner status and any missed payments." If your application is turned down, you should check your credit file: apply online at credit agencies Experian or Equifax for a £2 fee and challenge anything you don't understand or think is wrong. And when applying for a card, check the myriad costs and fees and ask how much you'll be charged for missing payments or overspending. (Source: The Independent)

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