Want to Build Credit with a High Interest Credit Card? Read this first…

credit-card-debt
2017-02-28

Everything you need to know before you get a credit building credit card.

Getting a credit card can be the fastest way to build up your credit rating, especially if you’ve had debt problems in the past. But rushing into taking on a credit card with good intentions all too often leads to disaster.

Ferratum have analysed recent statistics, including a recent study by the FCA. We aim to identify some of the problems with high-interest credit cards.

Risky business?

You might not feel like you would be at risk into falling into problem credit card debt, but you might be surprised at what makes you a vulnerable credit card user…

Card Newbie – If you are new to credit cards, you could quickly find that you’ve bitten off more than you can chew.

If you’ve taken on your credit card to build your credit rating, you may have had a limited choice of credit cards on offer. People with bad credit are also less likely to shop around for offers, fearing that multiple applications will have a negative impact on their credit score.

The FCA found in 2016 that a quarter of credit cards opened by ‘high risk’ consumers opened in 2013 were in arrears in 2014.

This could be down to poor affordability assessments, or unclear information surrounding the interest rates and amounts. Either way, if you are new to high-interest credit cards, you are at risk of developing problem debt.

The Minimum Re-Payer – You don’t need to have fallen into arrears for your debt to be a problem. There is also the risk to those that continuously pay the minimum repayment of their high-interest credit cards.

Making just the minimum repayment on your credit card means that it will take a significantly longer time to ever repay the debt in full. In addition to this, the high-interest rate being applied every month is often barely covered by the minimum repayment, meaning that it becomes near impossible to ever recover from the debt.

The FCA found that 8.9% of credit cards active in January 2015 will, based on repayment patterns and with no additional borrowing, take more than 10 years to repay.

I don’t have a debt problem

Sometimes it can be hard to identify your debt problem. If you haven’t fallen behind on payments then you’re doing fine, right? In reality, credit card debt is often already a problem before it falls into arrears. The FCA identified potentially problematic behaviour in their report. Does your repayment behaviour suggest you have a problem?

Persistent Debt - Are you consistently using 90% or more of your credit limit and have been incurring interest for over 12 months?

This behaviour suggests that you are perhaps in more debt than you can comfortably manage and are facing long-term debt that could take many years to repay.

Systematic Minimum Repayment Behaviour – As identified earlier, have you made just the minimum repayment for nine or more months while incurring interest over 12 months?

Continuously, making just the minimum repayment on your credit card suggests that you are not able to reduce the debt you currently owe.

Both of these behaviours are the most profitable for the credit card companies, which means that at the moment there is very little incentive for the companies to identify this potentially problematic behaviour early and encourage people to get out of debt.

Let’s break it down

It can be really hard to understand APRs and interest rates and what it all means in real terms. We’ve taken a couple of currently available credit card offer examples to show how credit card debt could mount up if not managed properly.

Product One*

APR

Amount of Debt

Minimum Repayment**

Total Time to Repay

Total Interest

24.7%

£1000

 

4.5% of outstanding balance

9 years and 1 month

£639

 

Product Two*

APR

Amount of Debt

Minimum Repayment**

Total Time to Repay

Total Interest

29.8%

£1000

 

4.5% of outstanding balance

10 years and 2 months

£856

 

Product Three*

APR

Amount of Debt

Minimum Repayment**

Total Time to Repay

Total Interest

59.9%

£1000

 

4.5% of outstanding balance

33 years and 0 months

£5297

 

*All examples are based on making the minimum repayment on £1000 debt with no further debt being added to the card and no changes being made to the rate of interest.

**Minimum repayment for all cards was whichever was greater; 4.5% of outstanding balance on statement or the full balance if less than £5 or 2.3% of the outstanding balance plus interest, plus fees, plus any insurance premium, plus the amount of any arrears which are payable immediately.

In 2014 the FCA estimated that around 1.6 million people were repeatedly making only the minimum payments on their credit card debt, while also incurring interest charges. So these examples could well be the reality for plenty of people.

So how can you avoid the dark side of credit card lending, follow our top tips below:

Shop Around

If you want a credit card to build your credit rating, then you should firstly try to shop around. On the FCA’s suggestion, many comparison sites are now offering a ‘soft search’ function that won’t affect your credit rating but gives you an idea of what kind of cards you are likely to be accepted for based on your credit file.

Be Realistic

As with all debt you should consider your ability to repay carefully. To build your credit rating, choose a card with a low credit limit (so you aren’t tempted to overspend!) and use only for small amounts so you can repay the balance in full each month. This way you will avoid the hefty interest fees and build those positive credit points.

Be Firm

If you show the credit company that you are responsible, you will often be ‘rewarded’ with the offer of a higher credit limit after a few months. Stay strong and refuse, a higher credit limit isn’t necessary when you are only using the card for small payments, to begin with.

If you’re considering using credit for an essential purchase, always choose a responsible lender. Don’t forget to check out Ferratum’s guide on how to choose a lender. It's also important to consider whether you are thinking about short-term or longer-term finance. Credit cards are, in general, better for short-term finance, which is why it isn't a good idea to only make the minimum repayment. Head over to the blog to find more ways to manage your money or click below to read about the dangers of weekly payment stores.

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References:

www.moneysupermarket.com

www.moneysavingexpert.com

www.citizensadvice.org.uk

www.fca.org.uk