Your Credit Cards: Handy Tool, Or Evil Vice?
As a kid, one of the first pieces of financial advice I ever received revolved around credit cards. “Don’t get one, they ruin your life”, or something to that extent. Owning a credit card was really a sin which was up there between outright stealing and drinking coke and then going to bed without brushing your teeth (my dad was a dentist). Credit cards have come in for a lot of attention recently, especially in light of the Royal Commission and responsible lending, so what’s all the fuss about?
For many people, owning a credit card can really be a shortcut to pain. Maxing out your card is bad, and going over the limit can have long standing repercussions which most ordinary people won’t have thought about.
Picture this: you’re around 20 or so and a student. You have a part-time job to support yourself while you’re at University, and the bank you’ve been with your whole life (because your parents bank with them) send you a letter offering you a credit card. You think of your upcoming holiday you’ve got planned and how it would be good to have a backup in case funds run dry, so you decide to get one. It’s only a $5K limit, what can go wrong? You spend a bit on the card, but nothing major. When you come back from holidays, the post-holiday blues kick in and you engage in a bit of retail therapy to cheer yourself up. Soon enough, you’re at your $5K limit, and you’re not in a situation to really pay it out. You just pay the minimum amount off each month, and then occasionally use it when you’ve got nothing else. Once the interest gets added on at the end of the month, you occasionally go over the limit.
Now, 10 years later, you’re still with the same bank, but you’ve long since paid out and closed the card, and you’re ready to buy a home. You approach the bank for a home loan, and your application gets declined. Most lenders won’t tell you why, but in most instances like this, it’s because they’ve had a good look at your past credit history and see you’ve gone over your limit a few times, and they think to themselves “damn, if this guy can’t even manage a credit card, he’s going to struggle with a home loan”.
Banks have recently put their hands up and admitted they could be doing more to encourage people to be more responsible. Previously, you’d just get your card statement which told you your minimum repayment amount. What it didn’t tell you is that if you only repaid the minimum amount, you’d end up spending tens of thousands of dollars to clear your credit card, and it could take you as long as 20 years. Now, there’s more information letting you know exactly how much interest you’ll pay if you only pay the minimum, and how long it will take you to clear the debt. I’ve spoken previously about personal vs corporate responsibility elsewhere, so I won’t go into it here, but whether they were pressured to, or because they thought it was the right thing to do, banks are now being more proactive in getting consumers to understand exactly how much their credit card will cost them in the long run.
It’s no wonder banks loved handing out credit cards. The interest rates were high, and it was an easy way for banks to make money. Also, adding more products to the mix for a bank (like packaging a credit card in addition to your savings account and home loan) is one of the simplest ways to ensure your customers remain “sticky”, i.e. they’re not going anywhere, simply because the more products you have, the more of a hassle it is to move everything across to a new bank.
So far, it all seems like bad news for credit cards, doesn’t it?
For just as many people, they’re able to use their credit cards responsibly, and can actually save money by having a card and using it as a tool to view monthly expenses. A simple way to keep track of monthly expenses for some people is to pay for everything on credit card, and clear it at the end of the month. If you’ve structured this with an offset account on your home loan, it can also maximise your offset benefit too. I won’t go into too much detail with exactly how to do this, but rest assured, plenty of people have credit cards and use them both responsibly and to their advantage. Add in the fact that many of the points programs with these cards can actually be quite generous, and far from being a problem, credit cards can seemingly be a source of free money, or at least, free benefits.
The good news for those out there who have run into credit card debt is that it’s usually pretty easy to clear if you also already have a home loan. You need a few things to line up, but it’s possible to refinance the home loan, and consolidate the credit card debt into the loan. This way, instead of having to pay the steep interest rates you get with credit cards (around 18-20%), you can pay out the debt at the same rate as your home loan (closer to 4%). To make things even better for you, you can create a loan split so that instead of extending your credit card debt over 30 years (the standard term for a home loan), you can pay it out much sooner. You get the best of both worlds, you clear your card, whilst simultaneously paying it out quickly and cheaply.
Clearing a credit card debt this way can’t just be a band-aid fix however. If you’ve run into trouble with your credit cards in the past, you need to be honest with yourself and use the above to genuinely turn a corner, not just pay out your old card so you can get another. If this sounds like you, there’s plenty of financial counselling services out there which can help put you on the right track.
If you’re keen on clearing up that credit card debt, I can help. Get in touch by emailing email@example.com.