Earlier this week I had a chat with 567 Cape Talk Radio`s John Maythom that
got me thinking.
John had discovered the extremely high interest rates charged on credit
cards and asked whether they are justified.
One of the main reasons why credit card interest rates are high is that the
debt on a credit card is what is called unsecured debt.
In other words, the bank cannot automatically claim a life assurance
investment, or your car or your home, if you do not pay up.
I do think that the difference between the rates you are paid when you keep
your credit card in credit, and those you pay when you are in debit, are a
bit wide. The differences between borrowing and lending rates range from
about 15 to 25 percent.
You must remember that you apply for and use a card by free choice. That
free choice includes making yourself aware of not only interest rates, but
also the other dangers of credit cards.
I do not think that many people who use credit cards realise the full extent
of these dangers.
Credit cards can be very useful instruments. They can give you a possible 55
days free credit on goods you buy. They also remove the danger of carrying
cash around in South Africa`s high-risk streets.
For many people credit cards have become debt traps of massive proportions.
Credit cards are, in many ways, money you do not have.
They are quick and easy to use. If you use them incorrectly, you are going
to be thumped in a number of different ways.
Here are the ways in which you can be hit hard.
Interest rates on credit cards are higher than many other interest rates.
On your credit card account you will find an interest rate quoted, but you
will actually be paying very much more if you do not pay your card in full
every month.
The reason is that the rate you are quoted is the nominal rate, not what is
called the effective rate of interest. What this means is that you pay
interest on interest.
The average interest rates on credit cards at the moment range from a high
22 percent, to an even higher 27,5 percent, depending which bank you use and
your type of card.
The top rate will effectively be closer to 30 percent, if you are only
repaying the minimum on your card.
There are a number of do`s and don`ts to credit cards, if you do not want to
dig yourself into a debt trap.
* Always pay back the full amount every month. If you are even one cent
behind on your payments, you will pay interest on every transaction, back to
the date on which you bought it that month.
Say you bought something for R2 000 on the first day of the new cycle, but
only repaid R1 950 when your account fell due, you would pay interest on the
entire R2 000, not only the outstanding R50. So at an interest rate of 25
percent, by being R50 short, you would be paying almost R75 extra in
interest.
* Never take advantage of the minimum payment syndrome. Credit card
companies and banks are very kind to you. They let you pay back a minimum
amount, if you wish, every month. The minimum amount is normally between
eight and 10 percent. But let`s see what that means.
Say your credit card account for the month is R5 000, which you used at the
start of the cycle, and the minimum repayment required is eight percent, and
the interest rate is 25,5 percent (I am using the rates that apply to my
card).
Minimum repayment required R400,00
Less interest payable on R5 000 for 55 days R192,00
Actual amount of debt repaid R208
So you have not reduced your debt by R400, as you may have thought.
* Beware the budget account. Nearly every card effectively gives you double
your credit card limit by having an add-on budget account. The interest rate
on a budget account can be between two and 2,5 percent higher than that
charged on the ordinary account and sometimes higher. There is nothing that
is budget about this at all, except that you will have to budget to pay a
hefty interest bill every month.
* If you have credit card debt, consider paying it from other debt you may
have, that has a lower interest rate, such as your mortgage bond.
* Make comparisons. Before applying for a credit card, compare the annual
fees between the various cards; the interest rates you will pay; and the
interest rates you will receive if you keep the card in credit balance. If
the rates change substantially, shop around again and apply for a credit
card that has cheaper rates. There is no reason to stick to any one card.
* Beware of loyalty programmes. See loyalty programmes as an add-on, not as
a reason to either take out a credit card, or to spend to build points for
an overseas trip. In comparing rates and costs when applying for a credit
card, take loyalty programmes into account as well.
* If you have credit card debt, consider paying it from other debt you may
have, that has a lower interest rate, such as your mortgage bond.
* If you have difficulty keeping credit card debt, destroy your credit card
today, pay back what you owe, close the account and stick closely to
cash.