Giving credit where credit’s due

By Grant Doyle

There is no doubt credit cards have their place. They represent quick and easy access to funds, especially in the event of an emergency. Apart from being a convenient short-term finance option, credit cards function as a highly effective payment device, reducing the need to carry excessive amounts of cash, notably when travelling overseas.

Cards are also the major tool of choice for buying online or over the phone. It’s difficult to think the likes of Amazon and eBay would be the businesses they are today without credit cards.

And as with most forms of borrowing, a credit card, when used responsibly with a realistic understanding of your spending patterns and lifestyle preferences can be an extremely useful tool in managing your financial affairs.

Not all cards are the same

There are 2 basic credit card types:

1. Low-fee cards with no loyalty programs or interest-free periods

2. High-interest rate cards with reward programs and interest-free periods

Whether you go for low-fee or high-interest cards, ensure you compare all aspects of a card before applying or switching, including annual fees and how minimum monthly repayments are calculated.

For example, the allure of ‘55 days interest free’ can soon dull if you don't pay the full outstanding balance (not just the minimum payment required) by the due date. Otherwise you could be charged interest right back to the purchase date on each item. Bang - there goes the interest-free period on those prior purchases.

Charge cards (e.g. American Express and Diners Club) are a variation on the credit card option in that you are expected to pay each monthly balance in full. Doing so carries no interest charges, but failing to pay on time carries stiff penalties.

Store cards are an alternative form of credit extended by retailers for exclusive use in-house. They are usually free of annual fees and attract a generous interest-free period. Plus, bonuses like extended warranties and exclusive cardholder offers can give store cards a distinct edge over regular bank-issued credit cards.

Affinity cards are similar to your standard credit cards but are linked to a particular cause or charity. Each purchase you make generates a donation to the designated charity. Used responsibly, affinity cards can be a genuinely altruistic endeavour.

Are you a ‘revolver’ or a ‘transactor’?

According to banks, we’re labelled ‘revolvers’ or ‘transactors’. Card issuers love revolvers as they feel the full brunt of interest rate accumulation by only paying the minimum monthly balance. Respected financial commentator Paul Clitheroe estimates that around two-thirds of us are revolvers.

Conversely, transactors play the banks at their own game by paying the full balance off each month. Annual or reward scheme fees are the only avenue of profit transactors offer the banks.

The trick is to identify where you lie and choose a card and conditions that aligns to your label. As Clitheroe writes in Making Money, transactors should opt for a card with an interest-free period: “This extends the period you have to get the cash together.” He emphasises the importance of making the full payment by the due date, “or you could lose the interest-free period altogether.”

Revolvers, on the other hand should choose a low-rate card: “The interest-free period is irrelevant as it only applies if the previous month’s balance is paid off in full,” he says.

Credit card calculator

FIDO, the consumer finance website affiliate of the Australian Securities and Investments Commission, has a very handy credit card calculator that enables you to calculate the effect of only making minimum repayments.

“A debt of only $1000,” says ASIC’s Executive Director of Consumer Protection, Greg Tanzer, “could take you as long as 11 years to pay off and cost about $860 in interest. Assuming a minimum payment of 2.5 per cent, an annual interest rate of 16 per cent and assuming you stop using your card,” says Tanzer.

Rewards can be anything but!

According to financial services research group Cannex, there about 270 credit cards with a points-based reward program attached. They essentially come in 2 varieties:

• One offering general points redemption of goods and services through selected retailers

• The other luring airline travellers.

“One of the main reasons consumers upgrade their rewards card is the capping of points, which can restrict your ability to save up the points needed to redeem a reward you have set your heart on,” Cannex’s financial analyst Harry Senlitonga says.

“A platinum card will give you more points per dollar spent in comparison to a standard card,” he says. “However it comes at a cost, which the card user should take into consideration when looking at the perceived value of a premium card.”

The average annual fee on a platinum card is $217, compared to just $34 for a standard card with reward. And while platinum is the king as far as rewards and luxury services go, Harry Senlitonga says you have to spend at least $70,000 a year to start enjoying the result.

Don’t overdo it overseas

Credit cards incur a variety of additional fees when used overseas. As such, they have become much more expensive than traditional travellers’ cheques.

Set fees or a percentage of the amount of cash advanced quickly add up with each withdrawal. Plus, interest on a cash advance is charged immediately, irrespective of any interest-free period inherent in the card. Then there are potential foreign exchange fees levied by the overseas bank that dispenses the funds as well as rate conversion fees imposed by your Australian card issuer.

If debt gets out of hand

There are several strategies you can adopt to avoid credit card debt derailing your personal finances:

1. Firstly, stop spending. As simple as that sounds, it’s your first step. While accumulating wealth is a gradual process, so to is getting back on track.

2. Secondly, consolidate multiple card balances by transferring them into one with the lowest interest rate

3. Thirdly, negotiate with banks or credit unions to roll up credit card balances into a personal loan or mortgage.

Consolidating multiple cards is being made increasingly easy (and attractive) by card issuers. Financial commentator and blogger (and host of Channel 7’s Sunrise program) David Koch says, that, “These days, with the average Australian owning more than two credit cards, many financial institutions are practically falling over themselves to offer the best deal on the market. That's why I reckon it's best to shop around, regularly review the cards you have and substitute better cards for the ones you aren't happy with.”