January 30, 2008
From the Sydney Morning Herald
by Annette Sampson
Are you suggesting my credit cards are out of control? Have another look at that January statement. Can you honestly say it wasn't something of a surprise? Even disciplined spenders can find their debts blow out after the silly season, and for those who were already in overload this period can be lethal.
So it's the ideal time to review your credit-card use to make sure they're not
costing you more than they should. Perhaps you need to start on a program to get that debt down or you've just ended up with more cards than you need or cards costing more than they should. Taking control isn't just about addressing debt; it could mean rationalising your cards or switching to a better deal.
Let's assume I've got more debt than I should. Where do I start? Cannex financial analyst Lauren Newlands says if you have a revolving balance (that is, you're carrying debt from one month to the next), the first step is to reduce the number of cards you have. "The simple approaches work best," she says. "Stop using your cards and cut expendable items from your budget so that you can increase your monthly repayments."
One of the most costly mistakes you can make is making only the minimum payment each month. That's because the minimum is usually a tiny percentage of what you owe - as little as 2.5 per cent - and after interest costs are added, you'll make little headway. The Australian Securities and Investments Commission calculated the costs of a $1000 credit-card debt with minimum repayments of 2.5 per cent or $10 (whichever is less) and interest charged at 16 per cent. (It assumed you made no further transactions on the card.)
It found if you just paid the minimum it would take more than 11 years to pay off that $1000 and you'd pay about $860 in interest.
Another mistake is concentrating on making extra home loan repayments while building up credit-card debt. Yes, it's a great idea to pay off your home loan as soon as possible but the interest being charged on your credit card may be double what you're paying on your home loan and it's a debt against consumables rather than an appreciating asset. "There are no positives to credit-card debt," Newlands says. "It makes sense to concentrate on [repaying] them first."
Fortunately, competition in the credit-card market can work in your favour. Newlands says if you have revolving debt on several credit cards, it can make sense to take advantage of a low or no-interest transfer offer. These allow you to transfer your existing debts to a new card and take advantage of a lower (or nil) interest rate. These offers can last for the life of the transferred balance but more typically they're for a limited period, such as six or 12 months, so you'll need to put serious effort into eliminating that debt during this period.
Newlands says it's a good idea to check what rate the balance will revert to if you don't pay it all off within the introductory period. It's usually the standard rate charged on new purchases but with some cards it's a higher rate that applies on cash advances.
Credit Union Australia managing director Graham Olrich says wrapping your card debt up into a low-rate personal loan may also be an option. "We'd suggest you also get rid of your credit cards or, if you want to keep one for convenience, look at reducing your limit."
Newlands says reducing your credit limits can also improve your chances of getting other loans, such as a home loan, as potential lenders assume you've borrowed the full limit when assessing your repayment capacity.
You mentioned rationalising my cards. How do I do that? The most popular credit cards are those with reward programs but they tend to also carry the highest interest rates and annual fees. So the issue is finding a card that suits your usage patterns.
"The question you need to answer honestly is: do I pay off my card in full every month?" Newlands says. "If the answer is no, the most important consideration is the interest rate, followed by the annual fee."
Newlands says you can still get benefits such as 55 interest-free days with low-rate credit cards but you need to look at their policy on cash advances (some charge a higher rate and most don't allow interest-free days) and when the interest kicks in if you don't pay your account in full.
If you're disciplined enough to pay your account off each month, Olrich says a reward-linked card may be an option, though annual fees and the level of rewards can vary.
Olrich says debit cards now have the same convenience as credit cards but, as you're spending your own money, you don't have to worry about running up debt. He says some lenders, such as CUA, have low-rate overdrafts linked to these cards for unexpected
expenses.