Young Investor

When plastic's not so fantastic

Around 70 per cent of Australian households have at least one credit card and together they've racked up a staggering $28 billion [1] in debt on them. Plastic cards are convenient, but for the financially undisciplined they can spell disaster ...

'Savings, cheque or credit?' It's easy to see why credit cards have become so popular. They're convenient, can be used to buy things over the phone or internet and, best of all, allow you to buy now and pay later. But paying later might have a bigger impact than you realise.

If you're financially disciplined, a credit card allows you to purchase goods, using someone else's money, without you having to hand over a cent for the entire interest-free period, which can be up to 55 days. In the meantime, depending on how you've set up your accounts, you can use the money to earn a little extra interest on your savings or save some interest on your mortgage. However, for this strategy to be of true benefit, you must pay off the entire balance of your card each month. It's not enough to pay the minimum payment, because you'll end up paying high credit card interest rates on the remaining balance.

Tips for credit card novices Read the fine print. Know the interest rate and, if there's an interest free period, how long it is, when it starts, how much you have to repay and when. Pay off the full balance every month. If you can't, pay the maximum you can afford. Examine reward and loyalty schemes carefully. Often you pay more for the goods (or spend more) than the value received in rewards. Don't get cash advances. They attract interest immediately and aren't repaid until all credit purchases are repaid. If you can't meet a repayment, don't ignore it. Talk to your card provider to devise a plan. You don't want a short term problem turning into a bigger one that will affect your credit history for years to come.

As for most non-tax-deductible debts, it's generally best to pay off a credit card debt as quickly as possible, especially when the interest rate is high.

Be careful when you pay out a credit card by merging it with another debt (such as your mortgage). It doesn't mean you've eliminated the credit card debt. You may have reduced your total monthly repayments, mainly due to lower interest costs, but the debt amount is still there, still growing, and still in need of urgent attention.

Say you consolidate your credit card debt into a standard 25 year mortgage [3]. If your original mortgage was $300,000, after 10 years you may have reduced it to around $236,000 with about 15 years to go. If you merged a $2,500 credit card debt into that mortgage, over the remaining 15 years you'd repay over $4,000 more. If the credit card debt was $15,000 (or $25,000) it would cost you approximately an extra $24,300 (or $40,500).

Becoming more financially disciplined

The best way to manage a credit card is to repay the full balance each month, or at least pay the maximum you can afford. Curbing your spending or cutting up the card help prevent you adding to your debt, but they don't have an impact on the debt you've already accrued.

Finding the extra money to eliminate debt is not easy. It helps to create a budget and stick to it. Extra money can be used to pay more off your credit card or other loans each month.

Consider using cash or lay-by

When was the last time you paid cash for a large item or placed it on lay-by? With today's widespread use of credit, the concept of lay-by seems oldfashioned. If you're unfamiliar with it, lay-by allows you to set goods aside and pay for them in cash installments. The downside is that you can't take the goods home until you've paid them off.

Lay-by might seem old-fashioned, but it's a great interest-free way to buy your Christmas gifts!

1. RBA - www.rba.gov.au September 2004 report and June 2005 report [back to article]
2. Based on 30 days per month, an annual interest rate of 15.99 per cent, and the minimum payment being the greater of $25 or 1.5 per cent of the amount owed [back to article]
3. Based on 30 days per month and an annual interest rate of 7 per cent payable over 25 years [back to article]

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