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Become Credit Card Savvy

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Make no mistake. Credit cards are designed to keep you in debt forever unless you are wise to them.

How? The repayment terms are designed to encourage you to pay the minimum monthly payment only, thus opening the door for outrageous rates of interest to be charged (up to 20% and higher) on the bigger portion that you don’t repay on time. Next time you look at your statement, you’ll notice that the Minimum Monthly Payment and the Due Date are together and quite prominent.  However, you should be looking at the closing balance on your statement. That is what you should be paying back each month.

It is interesting to note that banks and card providers are only required to assess whether you can pay the minimum monthly payment, commonly 2% of your credit card balance, not the entire amount borrowed.  No doubt change will come but it is slow.

So if you want escape the credit card trap you must use cards as a Transactor, not a Revolver.

Just in case you foolishly considered yourself a valued bank customer, Transactor and Revolver are terms used in banking parlance for people who pay back their balance before the expiry of the interest free period each month, and those who don’t.

Transactors pay off their closing balance each month by the due date and hence pay very little for the use of the card. On the other hand, banks and card providers make a fortune out of Revolvers. If you are a Revolver, you don’t (or can’t) pay back your closing balance in full at the end of the month; which means you are paying interest on outstanding borrowings at a rate of up to 20% or more, depending on your card.

And then there’s the Constant Revolvers.  This is bank-speak for Revolvers who are unable to pay back the balance month after month, and sometimes year after year.  With a rapidly growing card balance, they tend to be in debt forever. It is often the case that new cards are sought to pay off the existing ones and credit card debt balloons out of control.

Meanwhile, interest on interest grows rapidly while ever you continue to maintain an unpaid balance each month.  For every month that you allow your card debt to revolve to the following month you interest is rapidly compounding at very high rates. As for your interest free period, that is lost in the month that you don’t repay the closing balance and in the following month as well.  It becomes irrelevant until such time as you pay off your balance and continue to do so each month.

If you are in the Revolver group, then you are more than likely struggling financially and suffering stress. The irony is that you and the other 40% or so of Australian households who fall into this category, form the customer group that contributes most to the banks profits and share price.

a man in suit holding a credit card

Tips to Reduce your Credit Card Debt

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gary weigh

I find that people with significant credit card debt generally don’t like budgeting.  Most I meet as a financial adviser tell me that they are hopeless budgeters.   What they really mean is – it wouldn’t tell them anything they didn’t already know deep down, and because they don’t know how to change, there seems no point as they would not be able to live within its means anyway. 

Regardless, I still insist on a budget because it shows the depth of the problem and it helps prioritise spending.  After all, my job is to help, not judge!

The reality is people get into trouble with credit cards because they spend more than they earn and the credit card is being used to bridge the gap.  It occurs a lot with lower income earners but I have seen many couples on a combined gross income of $200,000 – 300,000 a year complain to me that they can’t make ends meet.  It is all relative!

When families can’t make ends meet, credit card debt increases and as each month passes, it becomes rising core debt.  Core debt means that the debt is not paid down to zero each month.  It therefore carries over to the next month where it is increased by new debt associated with current purchases.

Typically, this bad habit will continue for a couple of years until finally, at a crippling interest rate of between 15%-20% per annum, the debt eventually grows beyond the capability of the cardholder to manage it.

Growing credit card debt means only one thing – you are spending more than you earn.  Your two choices are simple – either to earn more or spend less (or both).

To reduce existing credit card debt:

  1. Obviously, stop adding more debt to your credit card
  2. Pay as much as you can afford each month as an extra payment in addition to the required minimum repayment, otherwise the number of years required to repay your debt, plus the total amount you will ultimately repay, will quickly blow out beyond your control
  3. To get some breathing space, renegotiate the interest rate on your existing debt either with your own bank, or take advantage of a better offer to transfer the balance to a new bank
  4. If you are a homeowner, consider consolidating your personal debts into your home loan and then increase your home loan repayments.  This would usually lower your total monthly repayments for all debt.  This may or may not be feasible depending on your circumstances, so it is important that you seek professional advice before you take action!
  5. If you are not a home owner, consider approaching your bank and ask them to convert your credit card debt to a personal loan.  Then work hard at paying off the personal loan.  Personal loan interest rates are generally lower than credit card rates.  This will generally lower the interest rate and therefore your decrease your monthly repayments.  This may or may not be feasible depending on your circumstances, so it is important that you seek professional advice before you take action!

Let me be clear:

“Using a credit card is the worst personal finance strategy you can think of!” 

If you have a credit card that is maxed out, or you have more than one credit card, you are either in financial trouble or trouble is looming and you should seek professional advice immediately.

Nobody needs a credit card.  For payment convenience in this cashless society, switch to a debit card where you are spending your own money, and not borrowing and increasing your debt every time you make a purchase.  At least then, when the account linked to your debit card runs out, it is an unmistakeable signal to stop spending.

Gary