Credit card: don't be taken in by the lowest rate

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The lowest interest rate on balance transfers can end up costing more.

When it comes to credit cards, few of us want to fork out on hefty interest charges. So it can pay to take out a card with a long interest-free period to reduce borrowing costs.

However, those who choose to rotate their debt from one interest-free card to the next can find this a false economy, as "balance transfer" charges can soon add up.

Six (SNP: ^SIXY - news) years ago the longest interest-free balance transfer offer lasted 12 months, according to uSwitch.com. Today, this has almost doubled. But at the same time balance transfer costs have also crept up. NatWest/RBS (LSE: RBS.L - news) recently increased the balance transfer fee on its Platinum Extended credit card to 3.5pc e_SEnD although it offers an interest-free period of 23 months. Barclaycard, Tesco Bank and Halifax all offer similar deals.

Last week, though, Barclaycard launched a new balance transfer credit card offering interest-free balance switches for 12 months and a discount on the balance fee of 1.2pc, bringing it down to 0.9pc. Yet the discount comes in the form of a partial refund of the fee, which you will get only if you complete the balance transfer within 60 days of taking out the card. It is not an interest-free offer on purchases, which will incur interest at a rate of 19.9pc.

"The credit card market seems to have developed into two distinct product areas: either a long 0pc term with high balance transfer fee or a shorter interest-free deal with a much lower balance transfer fee," said Andrew Hagger of Moneycomms.co.uk .

As with most financial products, when it comes to plastic, borrowers tend to focus on interest rates. The majority of credit card holders will often be tempted by a lengthy interest-free period on balance transfers advertised by the providers. But these borrowers would be ill-advised to assume that the longest interest-free period always offers the best deal.

Banks and building societies are well-known for giving with one hand and taking with the other, which is why the interest-free balance transfer periods come at a price and it is a price that may not be worth paying. It's very easy for borrowers looking for a new credit card to be attracted by interest-free offers, but it's vital to consider the transfer fees and the time in which you need to pay your previous debts off when comparing deals.

"Not everyone switching a balance is looking for a 20-month-plus term to repay the debt, some people are looking to repay inside 12 months but at the lowest cost," said Mr Hagger.

It is true that for some borrowers it may be worth paying a high fee in order to benefit from the longer term, but this depends heavily on the size of the debt and when it is likely to be paid off.

With a large balance that will not be repaid before the end of the 0pc term, the high fee can be worth paying in order to secure a longer interest-free period, as it will buy you more time to chip away at the debt. However, with a balance that you are likely to pay off more quickly, it may work out cheaper to keep the set-up costs low, so it makes financial sense to opt for a lower fee.

"Although the interest-free terms are much shorter than on the best buys, where you can get 22 or 23 months, the very low balance transfer fees will appeal to those people who want to clear their debt quite quickly but at the minimum cost," added Mr Hagger.

For instance, his figures show that those who opt to shift a £5,000 debt to Halifax's Balance Transfer MasterCard, which offers an interest-free balance transfer of 22 months, would pay a fee of 3.5pc costing a total of £175.

However, were you to move the £5,000 balance to NatWest's Platinum low balance transfer fee card, which offers an interest-free period of just 13 months with a 1pc charge, you would pay just £50 a saving of £125. However, those who want to make the most of these various deals will need to ensure that they have a healthy looking credit history, said Michael Ossei, personal finance expert at uSwitch.

"A market-leading product is only beneficial to consumers if they can actually get their hands on it," he said. "NatWest's previous 22-month balance transfer card proved extremely elusive for those without a squeaky clean credit rating.

"Having now stretched the balance transfer period by a further month, to just under two years, it remains to be seen just how many of those who apply will actually be accepted."