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It was in my 'schedule of topics to blog about' and it seems it is timely as in the past 3 weeks only I have been asked about the above topic on 3 different occasions. In addition to that my present wife(!) & I have just returned from a weekend city break to UK, and there is no doubt that flashing the oul' Visa Credit Card around the place is an easy pit to fall into, hence the reason I don't currently operate a Credit Card (that's why I use the term present wife!!).
The 3 people I have chatted to about the issue of Credit Cards in the past few weeks all have or have recently had fairly sizeable amounts owing on their cards, and all for various reasons. One was to pay day to day bills on a 1-income household and to tie them over till pay-day, another was an accumulation of expenses for house furniture and electronics, and the other was a big blow-out holiday last year. Each of them were really aware of the debt, however what was surprising was that two of the individuals were paying the minimum monthly payment only, and not making a concerted effort to clear the actual loan. Upon speaking to them this was not due to an inability to repay the debt but a lack of awareness of the cost of the debt. We are out to fix that in this week's Blog!
How Do Credit Cards Work?
Credit Cards may seem to many as a Celtic Tiger thing, when we over-indulged and purchased luxury items at a rate of knots and never bothered repaying them, only for the levels of personal unsecured debt to spiral out of control. They were, but they haven't gone away! Credit Cards are still a phenomenally profitable product for the providers, because for that very reason; many of us don't clear them each month and therefore pay really high interest on the balances and are exactly the type of customer which will generate very healthy profits for the providers. As outlined in our most popular Blog#3 we shared 5 basic principles in managing our finances, clearing debt and Credit Cards was one of them! So how not to do it?
The following are the steps involved in your being an ideal customer for a Credit Card provider:
- You Apply For Credit Card
- You Are Given Credit Card
- You Buy 'Stuff' On Credit Card
- You Repay The Minimum Repayment Amount Each Month (e.g. €10-€20 per month)
- You Are Charged The Maximum Interest On The Outstanding Balance (15-30%!)
- You Stay In This Pattern & Said Company Make Lots of Profit From You
If you were to follow steps 1, 2 & 3 however on step 4 you actually clear the balance the Credit Card provider will make next to nothing from your custom. Typically you can get between 30 and 60 days interest free credit on a Credit Card, which can be very handy! It is only when Credit Card users start coughing up the massive interest that the provider's gravy train rolls in!
The minimum repayment amount is a figure which will you are invited to repay on the card after a certain period of time of their being a balance outstanding on the card. Paying that amount will go nowhere near clearing your debt over a short period of time, typically it is a figure which will go towards paying the interest you owe at that point in time on the balance outstanding, plus fees. Therefore it is important to note that merely paying the minimum repayment amount is not in your best interests, if you can at all afford to pay more!
Why Get A Credit Card?
They are shocking handy! In the past they were particularly useful when we did not have Visa Debit Cards or indeed didn't use cheque books (how many of us here every wrote a cheque I wonder!?) and you needed to make purchases for items such as travel expenses etc. They quickly became a really convenient form of on demand personal loan, which is where it can get dangerous. However in today's society of 'see it- want it- buy it' the Credit Card can be a way of getting what you want without having to save for it, which in my book (not an actual book, yet!) is a habit which will erode your savings capacity and future wealth massively.
Can I Get A Credit Card Now?
After a few years of silence we now see providers back in the market of issuing Credit Cards; we are being enticed with cash-back offers, discounts on grocery bills, complimentary travel insurance and low introductory rates. We will shortly get to the latter and how it can be of real assistance to you in managing your Credit Card balance. So yes, provided you have a reasonable income and a reasonably clear credit history most providers will be open to doing business with you.
The providers are not giving these incentives for your benefit, they are profitable products and generate lots of income for them because many of us (including yours truly before I saw the light!) are often quick to purchase and slow to repay, a Credit Card provider's dream!
What Is My Credit Card Costing Me?
Every Credit Card attracts a €30 Stamp Duty fee per annum, no avoiding that one, unless you don't have one! We will run through an example of the cost of having a credit card and the interest payable on it, for illustration.
Credit Card Balance Outstanding €5,000
Rate of Interest is 23%
If you are paying €120 per month you might think that you are making progress, however it will take approximately 7 years to repay the €5,000 (assuming you cut up the card now and make no more purchases!). 7 years! Totaling just over €10,000 in repayments, €10,000!
If you decide you can pay more and repay €200 per month, you will have €5,000 cleared in just under 3 years time, a much much shorter period of time, and a much much lower amount of interest. Total Repayment of €6,900 approx. It is still a very saucy amount of interest, the typical rates of interest of 18-25% are really high and even over 3 years as above on a smallish amount can be quite difficult to stomach.
Should I Clear My Credit Card As Early As Possible?
Eh, yes! If you have the means to do so immediately then it can be a very prudent thing to do. Say you have €5,000 in the bank, and you have a €5,000 credit card debt it makes a lot of financial sense to clear that debt, and then start building your emergency, retirement, education funds etc thereafter. Purely on the basis of the prohibitive cost of the Credit Card.
Is There Another Way To Clear My Credit More Effectively?
Yes, potentially. There are 2 angles to tackle this from. The first is the good old fashioned 'ask for a discount' approach. It has been known to work in the past. If you contact your provider and ask them to reduce the rate on your outstanding balance, they may just do it!
Secondly, I mentioned above that many providers offer an introductory discounted rate, and indeed most offer 0% balance transfers. Essentially what that means is that once your are granted the card you can transfer your outstanding balance from the old card to the new card and not pay any interest on that for a period of typically 6 months. This allows you the opportunity to really pay off the actual loan of €5,000 and not just interest.
If you were to do this, and even if you don't get a better rate than the illustrated 23% on your existing card it can have a massively positive impact on the time it takes to clear the debt (again assuming you cut up the card on receipt of it so you don't use it!).
In the above example your €120 would have this new card cleared in just over 5 years instead of 7 years. Might not sound earth shattering however that is a saving of €2,800 approx, on a debt of €5,000. Massive!
In the case of the €200 monthly payment example you would have your debt cleared in less than 2 and a half years instead of 2 years 11 months, which is a saving of €1,200 on a €5,000 debt!
I was delighted to hear in one of the cases at the start of this piece that the couple who were telling me about their need to use the Credit Card to tie them over till pay-day have managed to clear their Credit Card debt, it is a financial as well as emotional weight lifted and allows them to focus on managing their money in a proactive way and to plan for some family events and milestones which are very close to their hearts, so well done to you guys down in Limerick, you know who you are!
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