Your lack of financial knowledge and your decision never to read the terms and conditions of your credit card contribute greatly to your financial downfall. You must understand that credit card use is a form of borrowing. It is not a source of free cash.
Credit card use is the most common form of personal borrowing in Australia. And there is a reason why they carry high interest rates. It is unsecured debt; and to any lender, unsecured debt is risky. So they charge high interest rates to everyone, knowing full well that some will default.
Unsecured debt means that if you can’t repay the money, the lender has no recourse to any asset you own to recoup your debt. Their only course of action is to engage debt collectors and pursue you through the legal system.
Contrast this with your home loan where the interest rate is quite low because the lender holds your home as security for the loan.
To be fair, banks and other card lenders do give you the opportunity to pay back the money borrowed within an interest-free period. If you do that, and you don’t concern yourself with bonus offers and rewards schemes and avoid making cash withdrawals, you won’t be charged interest or penalty fees.
So the smart thing to do is to educate yourself in responsible credit card use and play the banks at their own game. There is a way to use a credit card to your advantage but it is certainly not how most people use them. Most people are blinded by the availability of cash and the convenience of making purchases, and don’t realise that the money has to be repaid within a short amount of time.
That said, banks and other credit card issuers still use every trick in the book to encourage you into personal card debt. They also maximise profit on the back of your financial misery when you get in too deep.
Here is an outline of the top 8 sneaky tricks banks use to suck you into debt and keep you in debt. But realise that, at all times, they are taking advantage of your financial ignorance and lack of understanding.
- Interest free days
Usually you have 55 interest free days on purchases but this doesn’t mean that every purchase will be interest free during this period. If you don’t pay your credit card off in full each month, the interest free days won’t apply. Not only will you have no interest-free days in the month that you fail to pay the entire balance in full, but you won’t have them in the following month either because you carried over an unpaid balance. Also be aware that interest-free days generally do not apply to cash advances.
- Interest rates
Lenders lure customers in with low interest rates but this often a ‘honeymoon rate’ that only applies for a short time. Rates vary on purchases, balance transfers and cash advances. If you are paying more than 9% for purchases, you should shop around.
- Minimum repayment
Making only the minimum repayment is a fast track to having your debt spiral out of control. Why? Because if you repay only the minimum repayment amount shown on your credit card statement (commonly 2% of the closing balance), it will take you decades to pay it off; and you will be charged exorbitant interest of up to 20% or more.
In fact, you may never pay it off because as your balance decreases so does your minimum repayment amount. If this is your mindset, you will be in debt forever.
However, this is precisely what lenders want you to do because that’s how they extract the most money from you. The more money you pay in interest payments, the more profit they make. That is why banks cunningly place the minimum repayment amount and the due date together on your statement. It’s to fool you into thinking that the minimum amount is sufficient.
- Rewards points
Credit cards that carry reward points usually carry a higher range of interest rates than non-rewards cards. Please understand that rewards are not important to you. They are important to the card provider and then only as an incentive to entice you to use their credit card. Rewards schemes are costly to run and that is why you ultimately pay for it in the form of an annual fee and a higher interest rate structure.
Ask yourself is it worth it? It is common that you would have to spend in excess of $20,000 per year to make any reward scheme worthwhile. Even then, the rewards are usually not commensurate with the amount of money you have to spend. If you are in credit card debt the last thing you should be thinking about is a reward scheme. You should be reducing your spending, not increasing it.
- Bonus points and introductory offers
Banks and other card lenders use bonus points and introductory interest free periods to lure customers. They are relying on you to spend up big on your card without paying it off in full. Then they charge you exorbitant interest rates for the privilege.
- Balance transfer offers
Sounds like a great way to pay off your card by making the most of the 0% interest period on a new card issued by a new provider. However, beware! If you use your new card to make purchases, it is likely that all bets are off and you will be slammed with high interest rates.
If you read the terms and conditions, you will realise that you should cut up the new card or hide it and never use it. A friend of mine actually put hers in a container of water in the freezer and had time to think, while it defrosted, as to whether she really wanted to go ahead with the purchase.
Once the balance transfer honeymoon period is over your interest rate with the new provider will skyrocket, often to an interest rate of 20% or more. It is critical that you pay of the transferred balance within the honeymoon period.
- Cash advances
Withdrawing cash (i.e. making cash advance) using your credit card is probably the most expensive financial decision you could ever make. The interest rate for drawing cash is a lot higher than the already exorbitant rate for making purchases. Also there are no interest-free days on cash advances. Interest-free days generally apply to purchases only.
No wait …. There is a more ridiculous decision you could make. That is using your credit card while you are overseas to withdraw cash. This is far worse because additional hefty conversion rates and international transaction fees also apply. Travel cards and debit cards are far cheaper than this option.
- Even more fees
If you thought that the hefty interest rates that apply to your credit cards are bad enough, watch what happens if you go over your limit, or make a late payment or a payment that is less than the minimum repayment amount in any month. You guessed it; more hefty charges can apply. To use a credit card to your advantage requires that you walk a fine line. Step off that track and you will be charged with a fee and or high interest.
Audrey Dawson CPA and Gary Weigh Licensed Financial Adviser
Change My Fortunes
“Beat that credit card and personal debt and start kicking bigger goals”