How to avoid falling into the credit card trap
August 28 2015: Prominent financial journalists have told an Australian senate enquiry into credit card interest rates that banks are needlessly gouging consumers with high interest rates. That could lead to stricter regulations, but consumers don't have to wait for that to happen to use their credit cards more intelligently.
At the hearing yesterday, prominent TV commentators Ross Greenwood, David Koch and Paul Clitheroe said that irresponsible lending had led to $51 million in credit card debt for Australia, news.com.au reported.
Channel Nine's Greenwood argued that rates hadn’t fallen due to an increase in competition or product transparency. Instead, fees have become a means of extra profit, he said.
Channel Seven's "Kochie" argued that credit card providers have been neglecting their responsibilities by taking advantage of vulnerable applicants. "Credit cards have been a rort on so many different levels and generally it is the consumer getting skimmed,” he said.
Former Money host and chairman of the Federal Government’s Financial Literacy Clitheroe also fired shots at zero percent balance transfer deals.
“They are a debt trap,” Clitheroe said, arguing that banks took advantage of cardholders trying to consolidate their debts. While banks encourage customers to use balance transfers to reduce existing debts, Clitheroe argued that they can cause cardholders to spend more than they earned, a fact that banks often take advantage of.
Koch also pointed out the potentially deceptive and confusing nature of rewards cards. After recounting a bank credit card advertisement that read “buy fuel in Tamworth, fly to Thailand”, Mr Koch asked: “Where’s the advertising for the low-rate, low-fee cards?”
Greenwood suggested that future damage could be reduced if banks ceased targeting the vulnerable and provided consumers with standardised information. While banks and cardholders could both benefit from greater transparency and more responsible lending practices, there are some simple strategies cardholders can immediately adopt to protect their finances.
How can I pick the right credit card for me?
By asking yourself the following questions, you can make more informed decisions and ensure that your financial choices complement your spending habits and financial situation.
Balance transfer - What are the conditions of the promotional period?
If you have an existing balance, using a balance transfer card properly can be a good way to reduce your debt. If the card comes with a promotional rate of 0% for a certain number of months, there are a few things to consider to make sure the card is of value to you.
Before applying for the card, consider the length of the promotional period and the revert rate that will kick in once the introductory period is over. These tend to be much higher than the promotional rate. If you don’t think you can pay off your remaining balance at 0% before the end of the promotional period, you could end up paying more in interest in the long run.
Rewards card - do the rewards outweigh the costs?
If you’re a regular credit card user who has the ability to repay your balance on time, a rewards credit card can be beneficial. One way you can determine the value of a rewards card is by considering the points earn rate, the rewards on offer and the cost of the card. If the points earn rate doesn’t allow you to earn enough rewards points to offset any fees (such as the annual fee) that comes with the card, then the card isn’t in fact rewarding you.
You should also consider the rewards on offer and how many points it will take for you to redeem your desired rewards. If the amount you’d have to spend exceeds your regular spending habits then, again, you’re not being rewarded.
Choosing a credit card - compare your options
With the multitude of cards available on the Australian market, it’s easy to become overwhelmed by choice. There is no such thing as the single best credit card, as the most suitable option will always depend on the individual user’s financial situation and needs. Consider your spending habits, whether you have existing debts and what you can afford to determine the best card for you. If you merely require a credit card to fund necessary purchases, a low-rate or no annual fee card could be the way to go. If you often repay your balance on time, you may want to take advantage of a card with interest-free days to keep your interest costs at a minimum. On the other hand, if you regularly use your card, always repay your balance on time and consider yourself a frequent traveller, a rewards card connected with a frequent flyer rewards program could be of value to you.
The August 2015 Senate credit card inquiry is raising some valid points regarding the need for banks to take greater responsibility for clearly communicating relevant charges and assessing lending limits. But you don't have to wait for its outcome to make better use of credit cards right now. Follow sensible practices and you can ensure that your credit card relieves, rather than increases, your financial burdens.