The hidden costs of your foreign holiday money

Don't waste your hard-earned cash on high exchange rates and handling fees. Matthew Wall explains how to avoid the charges

Millions of holidaymakers will be paying over the odds for their holiday cash this summer because they did not do their homework before travelling.

Using credit and debit cards to withdraw cash from foreign ATMs may be quick and convenient but you will pay handsomely for the privilege. Why give money to banks when you could be spending it having fun?

One of the most expensive places to exchange money is at a foreign bank's cash machine. Not only will your card issuer charge a handling fee for using your credit or debit card abroad, some also charge an extra percentage of the amount withdrawn as commission. You can then get stung by a poor exchange rate offered by the local bank.

According to the financial comparison service Moneyfacts, there are very few banks or building societies that don't charge for using debit and credit cards abroad. The big banks levy a cash conversion charge of between 2.75 per cent and 2.99 per cent and then a cash transaction charge of between £1.50 and £5 on top of this. Only Norwich & Peterborough Building Society offers free current account usage when abroad.

Most card issuers also charge between 2.75 per cent and 2.99 per cent per transaction abroad, with the Post Office, Nationwide, Saga, Santander's Zero credit card and Halifax's Clarity credit card being exceptions.

Bear in mind that if you use your credit, rather than debit card to withdraw cash from a foreign ATM you will start being charged interest on the amount borrowed straight away. Then there is a handling fee of around £3.

Make sure you understand the terms and conditions of your particular card as there could be a minimum as well as a maximum charge. In this case, making lots of small cash withdrawals will mean the charges mount up alarmingly.

One way of avoiding card charges is to convert your cash before you travel. But foreign currency specialist ChangeGroup says the 17 million British holidaymakers who travel to Spain – a favourite destination – could be wasting £200m turning pounds into euros at higher rates than they need to pay.

Just because a bureau de change advertises no-commission deals, does not mean it is the cheapest. It depends on the exchange rate being offered. There are plenty of free currency converter applications for your smartphone, so you can cross-check exchange rates before you buy or withdraw foreign currency.

"People obviously need to shop around for the best foreign currency deals before they travel," says Michelle Slade of Moneyfacts. "Whatever you do, don't leave it to the last minute and change money at the airport – you'll be paying a premium for the convenience. And be aware that commission-free deals can mask unfavourable exchange rates. Sometimes it can be better to pay commission but get a better exchange rate."

Moneyfacts research finds Marks & Spencer and the Post Office often come out best for over-the-counter foreign currency deals, but online foreign currency sellers are also worth a look. Lower overheads mean they can offer better exchange rates. Two good-value online currency companies are ChangeGroup.co.uk and International Currency Exchange (ICE).

Research by ChangeGroup shows that if you ordered £500 worth of euros online you would receive around €549 from them. Doing the same at an airport via a Travelex bureau would buy you only €514 and you would have a card handling fee of £2 to £5 to pay on top. But HSBC takes the biscuit for charging a £5 handling fee plus a 2.75 per cent commission, meaning you'd only receive around €510 from the cash machine if you used your debit or credit card to get cash. That's nearly £35 worse than the online deal.

Using a foreign cash machine is certainly convenient and you don't have the risk of carrying all your holiday money with you when you travel, but it can be very expensive. Another way of avoiding card charges is to use a pre-paid foreign currency cash card and load it up before you travel.

Caxton FX, a foreign exchange company, does not charge for international cash machine withdrawals using one of its currency cards and claims to offer better exchange rates than most of the banks. You can load the card with up to £5,000 (€7,500 or $10,000) worth of foreign currency using your debit card by phone, text, or online at the exchange rate offered by the card issuer at the time. If you plan far in enough in advance, you can take advantage of exchange rate fluctuations and choose the best time. Once the cash is on the card, that's it. So long as your foreign transaction is in the same currency there are no exchange charges, handling fees or commissions to pay. There are now several currency card providers, including FairFX, myTravel Cash, Escape Travel, and BreadFX.

Another advantage of this type of card is that if it's stolen or lost, criminals can't take the money because it is chip and PIN protected. The card issuer has a record of how much was on the card at the time it went missing and can send out a replacement.

Don't use a pre-paid currency card to pay for fuel abroad though, as you may find the "shadow" charges made by the fuel company tie up the available balance, leaving you temporarily unable to withdraw cash.