The Christmas Card You Should Put Away
Sydney Morning Herald
Wednesday December 10, 2003
The strategy To get a grip on my credit card debt.
That's pretty ambitious at this time of the year! How do I do that? OK, I'm not suggesting you can have your debts cleared by Christmas - or even St Valentine's Day. But if you're going to do it, it's vital you temper your silly season spending binge with a bit of damage minimisation. Narelle Brown, the co-ordinator of Ryde-Eastwood Financial Counselling Services, says there's a danger this Christmas will be a bad one for running up credit card debt because of the recent interest rate increases. Borrowers paying more on their mortgages need to be careful they don't up their spending on credit cards to maintain their lifestyle over the Christmas period. It's easy to justify this by thinking you can pay the debt off afterwards, but Brown says too many borrowers simply assume that if they make the minimum repayment each month, everything will be OK.
It will, won't it? Not with the way credit card issuers stack the odds against you. Brown says most people assume that if they make the minimum payment on their card each month, they'll pay off their debt in a couple of years. That couldn't be further from the truth. Credit card issuers typically base their minimum repayment on 2 to 3 per cent of the outstanding debt (in one case, it was just 1.5 per cent), and if you stick to that repayment it can take years to pay off your debt.
For example, Brown says, if you had $15,000 outstanding on your credit card and paid off a 2 per cent minimum each month, you would take 31 years to clear your debt and pay $12,500 in interest. The Australian Securities and Investments Commission recently did the sums on a $1000 debt where the minimum repayment was 2.5 per cent of the outstanding amount or $10 (whichever was smaller). The credit card interest rate was 16 per cent. ASIC says that $1000 would take 11 years to clear and you'd pay about $860 in interest. As Brown's example indicates, ASIC found the bigger the outstanding balance on your credit card, the longer it would take to pay off. A $10,000 balance on the same card would take 27 years to pay off and cost $11,000 in interest, according to ASIC's sums.
Why so long? The main reason is that the minimum payment gets smaller as your outstanding loan decreases. With products like personal loans (and mortgages) your monthly repayment is maintained so you pay off more of the outstanding loan each month.
What can I do to stop this? The obvious thing is to pay off more than the minimum amount each month. Brown suggests finding out what the minimum repayment would be on a personal loan for the same amount and committing yourself to this amount each month. (You'll find the initial payment isn't much different, but it's paying that much each month that counts.) ASIC says in its examples you could pay off both debts in two years by paying an extra $50 or $500 a month respectively. If you're still using a high-interest credit card, Brown says it may be cheaper (and give you better discipline) to look at consolidating your debts into a personal loan.
What about transferring to one of those cards that advertises a low interest rate?
That can also work, though Brown says those advertised rates usually apply only for six months and will often end up more expensive than a personal loan. That's no reason for not looking at switching to a card with a lower ongoing interest rate, or doing things to curb your spending like cancelling non-essential cards and/or asking for a lower credit limit.
Budgeting is important, too - especially when it comes to controlling your Christmas spending. Make a list of what you need to buy, what you can afford, and stick to it.
© 2003 Sydney Morning Herald
