Credit cards: helpful or hindering?

Your credit card is much like your partner: convenient to have and makes you feel good but, let’s face it, you could live without it if you wanted to. Credit cards are also there when you need them but we always have to pay that needy little thing back in some way, even if it’s just at the minimum 3%, which causes headaches and sleepless nights.

Despite this, there are still 16.7 million credit cards in Australia and about $32 billion worth of credit card debt between them. This just shows that, like relationships, although credit cards can be a slight hindrance to our financial wellness, we always keep going back for more. It’s the good thing you just can’t quit because it’s always there in your wallet, waiting. Touting a bit of optimism bias to keep you from ever being concerned that you won’t be able to pay it back one day.

Although we’re all well aware of the dangers of having a credit card, we must admit that they can still be a real saving grace when it comes to covering costs that we don’t have the cash flow for at the time. If your cash flow is taking strain and you’re considering applying for a credit card to help ease your headache, wait a minute. Before you dive in, make sure you’re comfortable with the nature of credit cards, whether they’re worth the risk of impending debt or if you should just avoid them all together.

How can a credit card help your financial wellness?

Like always, there are 2 sides to every story. This means that credit cards carry both positive and negative connotations for consumers. Some of these will be obvious, especially to those who have a credit card of their own. But for those who have not yet succumbed to the false appearance of ‘free money’, here’s how a credit card could possibly help you.

They’re handy for emergencies

If you’re not the type of person that can avidly put money into an emergency fund, a credit card is a viable alternative. Obviously, it’s always best to be able to use your own cash because it actually belongs to you and doesn’t require paying any interest. However, if an emergency expense pops up and you’re not liquid enough to cover it, your credit card can act as your safety net. Remember, we’re talking about emergencies, not those liquids you consume on a Friday night with your mates.

You never want to be between a rock and a hard place when it comes to your finances so if you are faced with an expense that wasn’t predicted and needs to be cover ASAP, using your credit card will definitely soften that immediate blow.

Purchase power and ease of purchase

It’s amazing how you can just swipe a little piece of plastic or enter a few numbers online and have a brand new product or service in your hands. A credit card can make it a lot easier to make certain purchases, especially if you don’t want to be carrying around large amounts of cash (or just don’t have large amounts of cash to carry around), or if you are travelling.

Rewards

Many credits cards offer consumer reward programs that promise sparkling benefits. Spending? Great! Your credit card provider will give you more reasons to spend, disguised as discounts and special offers. While spending money on your credit card means you could be saving money somewhere else, you could also be tempted to buy something you never would have considered before.

Some examples of rewards programs include:

· Frequent Flyers

· Velocity

· Woolworths Rewards

· Citi Rewards

· American Express Explorer

· Fuel savers

These rewards are a huge bonus for consumers, especially if they’re going to be using their credit card regardless. Why not get more value out of your purchases by saving in other aspects of life? If you are thinking of applying for a credit card or you already have one but don’t receive any rewards, make sure you consider which reward programs are most relevant to you.

Protection of purchases

Similar to using a debit card, your credit card may also offer you additional protection if something you have bought is damaged, lost or stolen. A record of your purchase will show up on your credit card statement and your credit card company will also be able to vouch for the purchase. Some credit cards will even offer insurance on large purchases which provides extra security behind your spending.

No credit history? A credit card could help!

Credit is something you need whenever you want to apply for a loan, buy a house, sign up for a phone plan, rent a property or even apply for some jobs. Applying for a credit card and using it wisely can help you build up a positive credit score and history which will make life that much easier, but be wary…

A credit card can stunt your financial wellness

Now that we’ve looked at the positive side to having a credit card, let’s look at the negative one. Although a credit card can help you in many ways, it can also hinder you in many ways. Here’s how:

It’s far too easy to blow your budget

Being new to the credit card game is a very dangerous place to be. All of a sudden you have all this access to money in the slick, uber-cool sounding form of a credit card and you start to turn into a ‘yes man’. Nutribullet? Yes please. Apple TV? Absolutely! A baby goat? Why not?! You just swipe or wave that piece of plastic and it’s yours: but is it really? The answer? No. No, it’s not. Everything you buy with your credit card technically belongs to the bank until you’ve paid it off.

Credit cards encourage people to spend money they don’t have. You take that hunk of plastic home and the next thing you know, you’re opening a bill that brings tears to your eyes. You can spend hundreds of dollars in mere minutes and the longer you wait to pay it off, the more that baby goat is actually going to cost you. Here’s the trap — there’s a minimum repayment of about 3% which is calculated monthly, but there’s no fixed term. You could pay the bare minimum, and keep putting off that full repayment until when you (insert the thing you think it will take for you to be financially stable here).

Let’s talk about those interest rates

Credit card companies have the power to charge you enormous amounts of interest on each balance that you don’t pay off at the end of each month. This is how they make their money and why Australia has dug a $32 billion hole of credit card debt.

Let’s look at it this way: if you have $1,000 in your savings account, your bank might offer you around 2% interest per year on that amount. That means that at the end of the year, if that $1,000 has been left untouched, you could have $2,000 sitting in your savings. With your credit card interest, banks will generally charge about 7 times that amount (give or take a couple of percentages) on balances.

Therefore, if you owe $1,000 on your credit card at the end of any given month, you could be charged about $12 of interest at an interest rate of 14% per annum — most cards come at about 20% interest — for that one month. So, now you owe $1,012. Now, let’s say that your minimum monthly repayment is $50. That means that if you’re only sticking to that minimum repayment, you’re actually only making a $38 dent in your debt. If you were to ever only keep up with the minimum repayment amount, it would take you about 2 years to pay off that measly $1,000 that only took you 2 minutes to spend. That’s only if you don’t make any more purchases with the credit card for the full 2 years.

Credit card fraud

Like most possessions in life, credit cards can be stolen. You could lose your wallet and someone with sticky fingers might pick it up and take it shopping. You could be pick pocketed or someone could steal your credit card number off a receipt, over the phone scams or over the internet.

The good news that’s attached to this bad news is that if you realise that your card has been stolen, you can report it to your credit card company. This should be done immediately to make sure your card is cancelled and that you are not actually charge for any of the purchases the thief makes with your card. You will have to prove that the purchases aren’t yours and, while the bank investigates the matter you may have access to less funds.

Credit damage

While a credit card can be a good opportunity to build up your credit score, it can also be an opportunity to damage it. Missed credit payments and ongoing debts are recorded on your credit file and can impact your chances of getting a loan or other credit in the future.

Accessing cash is expensive

Unlike a debit card that holds money that is yours, accessing cash through your credit card can be difficult and expensive. If you were to make a cash equivalent transaction with your credit (e.g. gambling, buying foreign currency), you would be charged interest on that single transaction and your overall interest rate would increase.

Annual fees

On top of your annual interest, it is likely that you will be charged an annual fee. This fee will vary depending on many rewards you get with your card and the amount that your credit limit is set at. The more rewards and the higher the credit limiter, the higher the annual fee.

Options for getting rid of your credit card debt

1. Have a little patience — The most obvious solution, but the hardest thing to do. We’d all love our card balance to magically be wiped out, but there’s no fairy for that so you just need to stick to it and try to pay a little more than you need to each month.

2. Debt consolidation loan — this is great if you have multiple credit cards that you are paying off at the same time. You can use the consolidation loan to pay off all of your credit card debt and then you’re just left with one single monthly payment which is much easier to manage.

3. Balance transfer — A balance transfer is done by singing up for a new credit card with a different provider that will take on your debt and charge you lower fees to pay it off. Credit card companies are always looking to gain new customers so they will offer competitive balance transfer deals at times of year when people are most likely to be paying off debt.

4. Stop adding more debt to your credit card — If you’re only able to make the minimum repayments then it’s important that you stop using your credit card to make purchases. If you keep adding to your card’s debt and still only pay the minimum amount, you will never be rid of that debt. Put it in the freezer, cut it up or leave it at home in an obscure drawer — whatever it takes!

5. Pay more than the minimum amount — It’s pretty easy to throw an extra $50 a month onto your credit card repayments. That small amount will make a huge difference to your repayment period and the amount of interest you have to pay.

6. Set up a direct debit — It might be a good idea to set up a direct debit payment each month before your credit card payment is due with a set amount in order to avoid missing payments or making them late. Missed or late payments will incur more fees and damage your credit score.

7. Calculate your monthly repayment that will help control your debt — Your credit card company will give you a minimum payment amount that you will be required to pay each month. However, it’s a good idea to sit down and work amount the amount that you should be paying in order to get on top of your debt. To find out how much you need to pay each month to beat your debt, check out ASIC’s Credit Card Calculator.

Should I get a credit card?

Well, that is completely up to you! Credit cards can be hand things to have as back up but they should always be used wisely! If you do decide to apply for a credit card, make sure you have done your research and compare interest rate, rewards programs and annual fees to make sure you are getting the best deal. You must also make sure that you are 100% committed to paying off your debt and making payments that are higher than the minimum.

If you’ve had a particularly bad experience with credit cards, or you have your own tips on how to get on top of debt, we’d love to hear from you!