Simon Calder: Traveller's guide to Holiday money

As the half-term break begins, Simon Calder reveals the best ways to get the most from your travel cash

You researched your trip assiduously, and shopped around for the best price for everything from the hotel to airport parking. But if you leave holiday money to the last moment and change cash at the airport on your way out, you will throw away money that would be much better spent at your destination. Today, as the half-term holiday begins for millions of families, the one certainty is that many of them will get a far worse deal on travel money than they could obtain with a modest amount of research, and an understanding of how this strange business works.

British holidaymakers benefit from the most competitive travel industry in the world. Mile for mile, room for room, we get better value than any other nation. Yet there are still excess profits being made by bureaux de change and, especially, banks when providing holiday money. Next time you are near a bureau de change, note that they actually publish their gross profit margin. A typical airport exchange bureau might sell euros to departing travellers at a rate of 1.05, while it buys euros from incoming passengers at a rate of 1.25.

An example: Henri has just arrived from Paris. He sells €500 to the airport bureaux de change and collects £400. Behind him in the queue is Henry, who happens to need €500. Buying them costs £476. In a couple of minutes, the bureau de change has made £76 profit from willing, if foolish, customers, corresponding to 19 per cent. Other parts of the travel industry can only dream of margins like that.

There are, of course, many other elements at work, including some very high fixed fees – see "Cash – the best deals" for how to swerve past these. And some time-pressed travellers indisputably gain value by using airport bureaux de change. But as this Traveller's Guide explains, you need not spend much time or effort to reduce the profit margin dramatically and improve the odds in your favour.

Cash has many advantages: you have locked into an exchange rate, and therefore can calculate precisely how much that cup of coffee costs in sterling. Cash also says less about you than plastic, eliminating the risk of credit-card fraud. But it is also the target of every rogue from Calais to Kathmandu. While I rarely get robbed, it does take the edge off a trip when it happens.

For a century, the traveller's cheque was the safest bet. Providers such as American Express and Thomas Cook offered reassurance that lost or stolen cheques would be replaced free of charge at any of their worldwide offices – a service I once took advantage of when in Rome. (The queue of recently robbed tourists indicated the problem that the Italian capital has with crime against visitors.)

On trips to America, you could spend traveller's cheques like cash – pay for a $20 lunch with a $50 traveller's cheque and you were handed $30 in dollar bills as change.

All that has changed. In the US, proferring traveller's cheques is often regarded as akin to offering a personal "check" with no guarantee of payment. They have become a niche currency, and even something simple such as converting them to cash can be problematic, with high charges in the few banks and bureaux de change that are prepared to accept them.

Fortunately, there is a 21st-century alternative – the pre-paid card. These pieces of plastic can be pre-loaded in a range of currencies, again providing the advantage that you are "locked in" to a rate of exchange. But the margins taken by the issuing company vary substantially – see "Pre-pay hurray?" for details.

In this plastic world, pre-paid cards are only part of the answer. Debit cards are best regarded as a backstop, because of the high charges that most of the issuers impose. Credit cards are more reasonable and flexible friends. The two main brands, MasterCard and Visa, impose strict rules on merchants and banks about what they may charge, which provides some protection to the traveller.

One key stipulation is that paying by credit card should not cost more than paying by cash. This doesn't always apply: many airlines and holiday companies impose a penalty for credit-card payments. Some nations have their own laws, such as Denmark (where foreign credit-card holders routinely pay a surcharge) and Australia (where hotels add an extra percentage).

The rate of exchange is not decided centrally, though: each card issuer is free to set its own rates. In practice, these are typically about the same as the best rates you can obtain for foreign cash in the UK, so credit cards are a valuable part of the money mix. And, as "Section 75" reveals, they can also provide useful consumer protection for more expensive purchases.

These days, any traveller who starts in sterling needs all the help they can get.

Cash – the best deals

Foreign currency is the ultimate commodity: the euros or dollars you get cheap from a backstreet bureau de change are worth exactly the same as the notes you buy, expensively, at your high street bank. But the only way sensibly to compare rates is to ask the right question.

Ignore the smoke-and-mirrors nonsense of commission rates and service fees. Just ask: "I need €500. How much, in pounds, will that cost me?" Or "I want to change £1,000 to US dollars. How many will you give me?"

You can do this on the high street, where travel agents have at last begun to compete properly, and usually offer a better deal than banks. Even so, this week you would have struggled to get more than about €1.11 (against an inter-bank rate of around €1.15). Better is to order online at the Post Office (bit.ly/POcash will take you to the right place). You pay online with a debit card and pick it up at your local post office. This week, you could have scored around €1.12 at the Post Office. Not much difference? Well, on £500-worth it's a fiver saved.

Stepping up to the next level, shop around online and pick up the foreign currency at an airport or ferry port. Travelex.co.uk offers much better deals if you pay in advance on the internet and collect your cash at the airport. Indeed, last time I used this at London City airport to buy €500, it "saved" £40 on the normal airport rates (which only a mug or a very cash-rich, time-poor person would resort to).

For premier-league savings, you need to be in London. First, have a look at the website Thomasexchangeglobal.co.uk for just about the best rates you are likely to see – this week, above €1.13. You can pay online and pick up the cash at a Thomas Exchange office (eg Hammersmith tube station if you are on your way to Heathrow).

Better still, take a stroll along Britain's finest foreign-currency artery: Queensway in London W2. Within a few hundred yards, there are two dozen bureaux de change. It takes 10 minutes to compare rates, and with lots of tourists selling euros or dollars for sterling, there's a willingness to turn a quick profit – I got €1.14.

All of this applies only to the "big" currencies: the euro and dollar, and also the Swiss franc, Canadian and Australian dollars. You might also want to buy in advance for Scandinavian currencies or New Zealand dollars (weak competition at the destination means rates are rarely good). But just about every other currency counts as "exotic", and for these the rule is: wait until you get to the country in question. You will get a better rate on Croatian kuna, Turkish lira, Egyptian pounds and any other such currency once there. Change a bit when you land, then once you are settled wander around town to find the best deal .

Debit cards – the devil's work?

The most temptingly easy way to take care of your holiday money is the debit card. Just like at home, it works (unless your bank has blocked it or you've run out of funds) in ATMs abroad. And you can also use it in shops and restaurants showing the Visa or MasterCard symbol, depending on the issuer.

All well and good? No. It's not a "get-out-of-jail-free" card, it's a "get-some-cash-out-expensively" card. How much will it cost to withdraw €100? Well, you don't know. Some travellers still seem to think that exchange rates are handed down from the heavens and that banks adhere strictly to them. In fact, the market decides the exchange rate, which changes continually.

For the euro this week, sterling has wobbled around the €1.15 mark. So you might imagine you would see just under £87 disappear from your account in exchange for that €100. In fact, the bank will decide its own exchange rate – perhaps €1.11. On top of that, it will add a fee of around £2. That cash withdrawal has just cost you a fiver in charges.

And it gets worse. Should you be foolish enough to pay for lunch on your debit card, you can almost sense the bank rubbing its corporate hands with glee.

The "exchange-rate loading" charge is basically your bank helping itself to up to 3 per cent of the transaction, as well as a flat fee. Example: a €40 lunch translates to £36 at the rate the bank skews to its advantage; the bank takes another £1 as "exchange-rate loading" and then extracts a £2 flat fee. That's £39 for a meal which, had you paid with cash, should have cost no more than £36. The bank has helped itself to a 10 per cent tip.

Honourable exceptions include cards issued by the Norwich & Peterborough Building Society. But unless you have one of these, I recommend you keep your debit card as an emergency back-up.

One final warning: be wary of "dynamic currency conversion". This is where the foreign merchant offers the chance to "lock in" to a particular exchange rate: for a €60 bill you might be offered the certainty of paying £55. This is potentially useful for business travellers who want uncomplicated expenses, but otherwise it means that someone else is helping themselves to a bit of your holiday money: that transaction gives a rate of just €1.09 to the pound.

As safe as the Bank of England?

Sterling may look puny compared with its mighty run four or five years ago (since when it has lost at least a quarter of its value), but it still punches above its weight internationally. In many places, especially Commonwealth countries, it rates alongside euros and dollars for acceptability.

Once you are deep in the developing world, though, the US dollar is king. Almost everyone knows what the greenback is worth in terms of their currency, and a wad of low-denomination bills can help with many emergencies. In some places, for example Nepal and Kenya, you will be encouraged or obliged to pay for tourist services in dollars.

In the former Soviet empire, you might find that euros are equally or more acceptable: many nations were fond of the Deutschmark, and transferred their allegiance to the single European currency. Either way, you will need cash dollars or euros, and you need to follow the advice on the previous page to get them.

Credit-card crisis

All kinds of enterprises, from car rental firms to hoteliers concerned about their minibar, demand a credit card. Without one, you might be asked for a hefty cash deposit – or simply refused service. This is because the firm wants some comeback, and to reserve the right to extract additional funds. If, after you have checked in the car or checked out of the hotel, they find that you have run up a charge, they want to claim it back – and the easiest way to do that is to demand "pre-authorisation" up to a certain amount. They will exercise a "hold", which means reserving a chunk of capacity – perhaps as much as £1,000 – from your account for contingencies. This money will not leave your account (unless there has been some tomfoolery on your part), but it does limit your finance-related freedom. Suppose, for example, your credit limit is £5,000. Your balance is typically around £2,000, but on holiday you like to splash out. So a trader who blocks £1,000 can seriously impede your spending headroom.

What can you do? Well, arguing the toss with the merchant probably won't get you far. Instead, try to get your credit limit raised. You should in any case let the company know that you're travelling, so that when your spending pattern suddenly changes from the weekly shopping in Macclesfield to a string of transactions at Machu Picchu it does not trigger security alarms with your bank.

Pre-pay hurray?

The biggest shift in travel money over the past decade has been the growth in pre-paid cards, which you can load with currency – usually sterling, euros or dollars – and use to pay for goods and services, or to withdraw cash from ATMs. On longer trips, you can

keep topping them up online from your bank account, making them ideal for globetrotting tourists and gap-year adventurers.

But do your homework. The key components you need to compare start with the initial fee. Some providers waive this, but often make up for it with higher charges elsewhere. Paying £10 now (eg for the FairFX card) may actually save you more in the longer term.

Next, do you have to pay a "loading" fee? If so, this could prove expensive. Some companies demand 3 per cent of all the money you put on your account. One excellent exception is the Escape MasterCard (£9.99) from Phones4U, where you can wander into your local shop and hand over sterling to replenish it.

If you're buying in a foreign currency, what is the rate likely to be? Get a snapshot of the prevailing rates before you decide (or check Moneysupermarket.com or Moneysavingexpert.com).

Finally, is there a flat rate or a percentage charge for using the thing? If you mainly want to withdraw cash, go for one that makes no charges for ATM use, such as the Travelex Cash Passport.

As with traveller's cheques, keep your details safe so you can cancel the card if it goes astray. Without a PIN, villains should be unable to use it. And if you go for a provider such as Caxton FX, a replacement card will be sent out.

Section 75

No, it's not as exciting as Area 51 (the district around Roswell, New Mexico, where aliens are said to have landed in 1947), but it might be more useful. This bit of the Consumer Credit Act 1974 makes the card provider jointly liable with the merchant for any purchases over £100. That means the goods must be of reasonable quality – so if that new laptop expires shortly after you get back from Hong Kong, you can consider making a "chargeback" claim.

You are also protected against financial failure of a travel provider, whether an airline, tour operator or hotel.