Credit cards are the easiest way for people (especially young people), to get themselves into financial difficulty. It is easy to obtain credit, it is easy to use the credit and the interest rates are horrific. It is simple to put yourself into a position that makes recovery difficult.
Many people don’t even consciously decide to get a credit card. They often come with the loan or account they have set up and, at some point, they just start using it.
Others obtain a credit card with good intentions. A popular strategy is leaving all your income in an offset account to reduce your home loan interest cost whilst paying everything with credit cards. If you manage to stick to this strategy – it will work. The problem is that, many don’t pay off the credit card bill each month and, before they know it, they have a hefty credit card debt.
I hear of people obtaining a credit card so they can accumulate points or, only use it to buy stuff online, both with the intent of paying off the debt during the interest-free period. Again, despite good intentions, the debt doesn’t get paid during the interest-free period and a credit card problem develops.
The interest rates on credit cards are huge (most are around 20 per cent), so even with a relatively low debt, the interest costs can be very high. This is exacerbated by the fact that there is no pressure to bring this debt down with no loan term in place. Quite the reverse, the banks are happy to keep the debt levels steady.
The minimum monthly repayments are generally set at two per cent of the balance. Given the high interest rates, this barely covers the interest costs. On a $2,000 debt, the minimum repayment is $40, and, assuming the interest rate is 20 per cent, the interest costs are $33.33.
Barely any principal is being repaid. You can also add more debt on top of this by continuing to use the card.
If you want to get rid of this debt, you need to make a conscious decision to do so. Consolidating to a debt arrangement with lower interest and a finite loan period is often a good strategy. This may not be possible for some people, in that case, it is necessary to implement your own payment plan that will reduce this debt, not just cover the interest cost.
If you do consolidate into a new debt arrangement, it is very important that you do not repeat the same mistakes and accrue more credit card debt that needs to be dealt with in the future.
Alex McKenzie, Future Financial Services
Alex McKenzie is a financial planner, and the owner of Future Final Services in Penrith. He is a graduate of Western Sydney University.