Why do you have a credit card?
For any of you who regularly follow my posts on Facebook, it will come as no surprise that I'm not a big fan of credit cards. The reasons for this I explain below, but needles to say, as a finance broker I get to see a lot of the hardship people can get into by the poor use of credit cards and the very real personal and ongoing financial difficulties this can create.
These difficulties are not only from a monthly cash flow perspective, but also the damaging impact it can have on credit records and limitations it places on people's ability to borrow money for important things like the purchase of a home.
Some home truths about credit cards;
The 4 C's - (Credit Cards and Consumer Crap) - Let's face it, we predominantly use credit cards to spend money we don't have on crap we don't need and very often for people we don't like. Why do we do this? Well I really don't know, buying stuff is fun I guess and who the hell wants to wait until we can afford it in this day and age.
The problem with this attitude is there is no long term value in it e.g. aside from the short lived 'emotional high' you receive from buying stuff, it is bad debt and it attracts very high interest rates. If you did a quick calculation of the purchase price vs the current value of all the 'assets' you purchased using your credit cards over the last couple of years you would be alarmed and severely depressed.
Limit Increases - My number 1 pet hate when it comes to credit cards.
Does this sound familiar,
Dear Sir/Madam as a valued client and in recognition of your excellent credit history, we are pleased to offer you a credit limit increase of $.........
What the lenders are actually saying is this;
Dear Sir/Madam as a valued client, we notice that you are managing to pay of your credit card every month and this means we can't charge you a very high interest rate and make lots of money off of you. We are increasing your limit because we know you're human and will feel good about this limit increase and will happily put yourself further in debt by buying more useless stuff, paying more interest and increasing our profit.
Hugs and Kisses....Your Bank
You see, we as humans are predictable, very predictable...and not that smart. Lenders know this and use it to their advantage. Have a think about how you felt when you received that letter offering you the credit limit increase. Everyone I talk to about it says the letter made them feel good, grateful even. No one stops to ask why are they offering me this? or do I even need this? Nope, we all just sign up to more high interest, high fee consumer debt without batting an eyelid.
Bottom line, lenders make money from you when they can charge you interest (and fees) on the money you owe. When you pay off your credit card every month, they don't make as much money. Credit limit increases can lead you to creating more debt which leads to more interest, more fees and so on so forth....you get the picture.
Just for interests sake, Australia's average credit card debt currently stands at $4273 and annual interest is $735/pa.
Rewards Points - Seriously, I mean seriously. "Rewards" is one of the biggest misnomers I've ever come across to describe this system of points received for dollars spent. On face value it sounds like a good idea, it's even better if you take maths out of the equation and completely ignore human behaviour. Lets look at a couple of realities;
1) Most rewards cards return around $5 for every $1000 you spend (or 0.5%). However if that $1000 stays on your credit card for just a month at 18% interest, you end up paying $15, if it stays on your credit card for a year, you end up paying $180, clearly a waste of money.
2) Rewards Cards attract higher fees - this can be as high as $700/yr just to have the card. This would mean you would need to spend $150,000 in a year to earn enough points just to break even with the fee.
3) Value of Items - So you've managed to accumulate enough points to buy some more 'stuff'. Woohoo! now you get to pay full retail price in the 'rewards store' for the same stuff you could buy cheaper nearly anywhere else.
Credit Record - your credit card limit affects how much money you can borrow. Lenders will take your limit (not your current balance) into consideration when determining what they are prepared to lend you. In their eyes, your credit card limit is money you could access tomorrow and therefore it needs to be taken into account when determining your ability to service (pay back) any new loan.
An example, if you had a credit card limit of $10,000, it would remove (2-3% of the limit) or $200-$300/month from your loan serviceability calculation. In real terms, this means your borrowing limit would be restricted by up to $30,000.
Reality check, the home you want or a credit card to buy stuff you don't need, I know what I'd prefer.
Practical Solutions to the Credit Card Conundrum
1) Save up and use cash to by consumer items like tv's, use credit to purchase appreciating assets like houses.
2) Do a budget, and do something radical like stick to it.
3) If you absolutely have to have a credit card, have a bare bones low/no fee card.... but lets be honest, you don't need one, you just want one.
4) Lower your limit... yep you read it right.
5) Stay away from rewards cards, they mostly reward the lender.
6) If your current credit card debts are out of control. Look at consolidating them to a low interest loan. Once this is done, cut up your cards and close your credit card account....and slowly back away, don't stop.
Finally, don't get a credit card in the first place, if a lender offers you one....say no.