Credit cards can be a great way to free up your cash flow and build your credit history, but these are the mistakes and traps you should avoid.
Credit cards can be a useful financial tool if used properly. However, there are a number of pitfalls that you should watch out for to keep your finances under control. Aside from interest rates and annual fees, here are some of the credit card traps you should guard against when you’re paying with plastic.
1. Highest interest is repaid first
The bank is required to pay off the debt that’s collecting the highest interest rate first. While this is designed to help you avoid high interest costs, it’s important to remember when you’re budgeting to pay off your credit card debt.
For example, if you’ve used your card to make a cash advance (such as an ATM withdrawal), this will usually collect a higher interest rate than your purchases. So if you’re paying off a debt with a 0% balance transfer offer, but also use the card to make a purchase, your repayments will go to paying off your purchases before your balance transfer. Interest-free balance transfers only last for a promotional period, so you should make sure you know exactly where your payments are going to make sure you’re not wasting this 0% period.
2. Minimum repayments
Each month, cardholders are required to pay a minimum repayment which can vary from 2% or 3% to 10% of your total balance each month. Paying the minimum repayment will help you avoid late payment fees, but it won’t help you pay off your debt faster. This is because although you may have paid off 3% of your balance, 97% of your balance remains to collect and grow with interest.
If you can’t pay your balance off in full by the statement due date, you should at least pay as much as you can each month. This will help reduce your overall interest costs and can help you avoid unmanageable debt.
3. Late payment fees
As mentioned above, if you fail to pay at least the minimum repayment, you’ll be charged a late payment fee. Not only can this cost add up, but late payments will also leave negative marks on your credit file. This can then decrease your credit score and make it harder to apply for other loans in the future.
You can use finder’s guide to credit card late payment and overlimit fees to see how much you could be charged if you can’t pay your credit card bill on time.
4. Balance transfer fees
If you’re struggling to pay off an existing debt, you can use a balance transfer to move your debt to a card with 0% interest for a promotional period. This can help you save on interest costs and pay off your debt faster. Although you’ll pay no interest for the promotional period, some of these cards come with a balance transfer fee.
This fee is charged when you first move the balance and is usually between 2% or 3% of the total balance. So if you had a $7,000 debt with a 2% balance transfer fee, that would cost you $140. If you’re also paying an annual fee, this can really eat into your overall savings.
Not all cards charge a balance transfer fee, so you should keep this in mind when you’re comparing your options.
5. Cash advance fees
Using your card to make a cash advance (whether it’s an ATM withdrawal, gambling transaction or purchasing a gift card) can be expensive. This is because cash advances collect high interest rates which usually range between 20% and 22%. Unlike purchases, cash advances also start collecting interest immediately (rather than at the end of the statement period). As well as a higher interest rate, most cards also charge a 2%-3% fee for using your card for cash advances.
You can avoid this by using your debit card for ATM withdrawals and gift card purchases, just to give one example. If you’re unsure what your bank considers a cash advance, you should be able to find a list in your card’s product disclosure statement (PDS). You can also use finder’s guide to cash advances for a full list of what usually constitutes as a cash advance and the costs you can expect.
6. Rewards programs
Credit cards linked with frequent flyer and rewards programs entice cardholders to spend to earn points which you can redeem for rewards such as free flights or merchandise from a rewards store. This is a great way to reward your plastic spending if you repay your balance in full each month.
However, these cards usually come with higher purchase interest rates and annual fees. So, if you often carry a balance from month to month, the interest you’ll collect can easily outweigh the perks of a rewards program. If this is the case, you’re better off considering a card with a low purchase interest rate.
7. Foreign travel fees
If you’re using your card to make a purchase overseas, you may be charged a foreign transaction or currency conversion fee. Not only is this charged when you spend overseas, but also when you’re shopping online with an international retailer. Even if you’re shopping with an Australian brand but their payments are processed overseas, you could be charged a foreign currency conversion fee.
If you’re planning an international trip, travel a lot for work or regularly shop online with international retailers, it could be worth considering a card with 0% foreign transaction fees to cut back on this cost.
8. Promotional offers
Whether it’s thousands of bonus points or 0% on purchases or balance transfers, many banks offer new cardholders promotional offers to entice sign ups. Although these can be a great way to get extra value from your new card, these introductory offers usually come with a catch.
If you’re comparing a frequent flyer credit card, you’ll notice that you usually have to meet a spend requirement to get the bonus points. For example, a card may offer 100,000 Qantas Points but you’ll have to spend $5,000 in the first three months to get them. If this spend aligns with your credit card budget, it’s an easy way to boost your balance. If not and you’re unable to pay off the balance by the end of the statement period, you could find that the interest costs outweigh the value of the points.
If you’re looking for a card with 0% on purchases or balance transfers, remember that these offers only apply for a promotional period and will collect the higher revert rate at the end of the promotional period. We’ll talk more about the dangers of revert rates below. So before you’re swayed by the promise of a promotional offer, you should check out the eligibility requirements, offer end dates, promotional periods and revert rates before you sign up.
9. Revert rates
If you’re comparing a card with 0% on purchases or balance transfers, you may wonder why a bank would let you pay off your debt interest-free. There are two reasons for this. The first is that these promotions are an acquisition tool that the banks use to entice new customers to sign up.
Secondly, the bank predicts that cardholders won’t be able to pay off their purchases or balance transfers before the promotional period ends. Once the introductory offer ends, the remaining debt will collect interest and that’s how the bank makes money from you. If you have a card with 0% on purchases, any remaining debt will collect the standard purchase rate which is usually between 19% and 21%. If it’s an interest-free balance transfer offer, any left over debt from your balance transfer will usually collect the standard cash advance rate which is usually around 22%.
If you want to avoid these revert interest rates, set up a budget plan and determine how much you’ll need to pay each month to clear your debt before the 0% promotional period ends. For example, let’s say you have a card with 0% on purchases for 12 months and you’re planning to spend $5,000. You’d need to spend around $417 each month to pay off this debt before the standard purchase rate applied to your debt.
10. Keeping your card for years at a time
Although it may appear more convenient, you could miss out on competitive new offers if you hold on to the one credit card for too long. Instead, once you’ve paid off your credit card debt or used the card for a year or so, you may want to start comparing other offers.
You can compare offers based on your needs. So if you’re struggling to pay off your debt because of high interest, you might want to move your balance to a card with 0% on balance transfers. If you’re only using your card for emergencies and always pay your balance in full, you could consider a card with $0 annual fee. Or if you have some big ticket purchases to make, you could consider a card with a low or 0% interest rate.
As long as you’ve paid off your debt, there’s no reason you might not want to close the account and search for a more competitive offer. See our step-by-step guide to closing your credit card account for more information.
You should only apply for one credit card at a time and avoid having too many open accounts at once. Before you switch to a new card, you should check the eligibility requirements and request a copy of your credit score before you apply.
These are just some of the credit card traps you should avoid. Doing your research when comparing cards, creating and sticking to a budget and regularly looking for more competitive offers can help you keep your plastic in check.