Getting into credit card debt is easy (and usually instantaneous!). Getting out of debt is hard (and almost never instantaneous!). Debt hangs around like a bad smell!
A recent survey in the US showed that the three most common reasons for credit card debts were: unexpected medical, unemployment or university expenses. Note the word ‘unexpected’. The truth is many expenses are ‘unexpected’. So, we should simply allow for them when we are planning our finances.
The vast majority of credit card related debts could be easily prevented by the use of an “Emergency Fund”. An Emergency Fund reduces the impact of unexpected expenses and ensures that we always have sufficient funds for a “rainy day”. I normally suggest that people have about six months worth of living expenses in a bank account to allow for the unexpected.
A Credit Card balance of just $5,000 takes $7,143 in pre-tax income, assuming a 30% tax rate. It also assumes a once-off payment and no allowance for interest.
The interest rate on a typical credit card these days is around 18% and you pay off your credit card debt with after-tax income. This means the “real interest” is over 30% for most of us.
If you owe $4,300 on your credit card and pay the Minimum Monthly Amount, as required legally, then:
• You will pay roughly $790 per annum interest; and
• It will take a whopping 31 years to repay!
A number of Credit Card companies try to entice you with loyalty programs offering “Loyalty Points”, based on your use of the card. However, many of these programs:
• Are designed as marketing tools to encourage spending. So whilst you get an instant benefit, you get an ongoing expense with interest!
• Furthermore, the points can be hard to use and usually benefit the already rich who have high consumption patterns.
• When you take into account the Annual Fee charged by most of these companies, a Loyalty Program is usually not worth it.
And as I always ask? Do you really think an airline or credit card company going to give you something for free? Not likely.
• Pay off credit cards in full each month. If you are unable to do this, cut them up immediately to prevent them from becoming a problem.
• Reject credit card “Limit Increase” offers.
• Switch from a credit card to a debit card and you eliminate future credit card debt completely!
• Look around for cards that have little or no fees, even if they have no points program.
If not used wisely, credit cards can be a source of ongoing temptation and a real brake on getting ahead with your finances.