Credit cards are a financial time bomb
This is the time of year when many families realise they have spent more than they expected. Credit card debt and personal loans can be a costly trap for the unwary and this should surely be included in any school curriculum.
The harsh reality is that it's easy to become subject to interest charges at rates as high as 20 per cent per annum once a credit card is used for a cash advance or if the balance is not paid off in full by the due date. The normal interest-free period does not apply to cash advances or to any purchases on cards with outstanding debt from the previous month.
Making only the minimum monthly payment can be tempting when dealing with cash-flow problems but often it leads to even worse difficulties. Not only does that decision result in interest charges on the whole outstanding balance at the end of the credit period, but also there is no further interest-free period on future purchases. Unless the outstanding balance including accrued interest is paid off in full immediately, the outstanding debt will increase rapidly.
A high interest rate compounded on a daily basis will result in a ballooning of the outstanding debt. For example, an 18 per cent credit card interest rate will result in the debt doubling in four years even if there are no further purchases on the card.
Lower mortgage interest rates have lately led to a reduction in personal debt and a significant increase in personal savings. However, it's not always realised that there are larger benefits to be gained by concentrating on paying off any credit card and personal debts rather than by applying the savings to speed up the mortgage loan repayment.
Where necessary, there are further advantages in redrawing money from the mortgage to clear credit card debt completely. The interest savings and cash flow benefits from this strategy are substantial but only if the credit card debt is kept under control in the future.
Borrowing against the personal home for consumption purposes is not a viable long-term policy, but it can assist in dealing with an immediate debt problem. Buying items on sale with a credit card will be a bargain only if the debt is paid off with no or minimal interest or card charges. Otherwise interest accruing on the outstanding card debt will remove or greatly reduce the benefits of the sale purchase.
In summary, consumers need to be aware of their borrowing costs and to focus on avoiding the excessive borrowing costs of credit card and personal debt. So far, financial institutions have not reduced their interest charges on these debt categories despite the substantial fall in the official interest rate.