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Do you Carry a Credit-card Balance?

Is a credit card a convenience of modern life, or a temptation to go into debt? There are many misconceptions about credit cards. Diana Clement explains.

16 February 2022

Are you carrying a balance on your credit card? That means you’re not paying it off in full each month. Perhaps you only pay the 2 per cent or 5 per cent minimum, or roll some of the debt over.

Doesn’t everyone carry a balance? you ask. Marketers have worked long and hard to convince us that carrying a balance is normal. Even the words “carrying a balance” mask the reality, which is “being in debt”.

Kiwis paid NZ$546 million in credit card interest in the year to September 2021, according to the Reserve Bank of New Zealand. That’s $146 for every adult – and a lot of wasted money.

Plenty of people, both young and old, don’t carry a balance. Most either don’t have credit cards at all or pay off the balance on time every month.

They’re saving themselves hundreds or sometimes thousands of dollars in interest each year which, invested wisely, could be growing in their favour.

Yes, credit cards can be useful for true emergencies. Everyday spending classed as “emergencies” leads to debt, however.

Fake money

A credit card limit isn’t savings. It’s fake money that comes at a cost.

“These days, there’s a sense that your credit limit is your money,” says Te Ara Ahunga Ora Retirement Commission personal finance lead Tom Hartmann. That mentality keeps people in debt.

Credit cards were originally designed to take a larger purchase and spread it out over a number of smaller payments, says Hartmann.

“What credit cards effectively do is, little by little, ratchet up the amount of debt you’re carrying.”

That means your debt snowballs. Every month an unpaid balance gets bigger and bigger because of the interest charge added to the balance. Invested instead, that money could be growing in your favour.

Carrying a balance translates into paying an average of 18.2 per cent interest more than everyone else for whatever you’re buying. It takes over a year to pay the money back, the cost continues growing. It’s an expensive way to live and not wise, financially.

If you want to get ahead, the reality is that you need to ditch all consumer debt, including ‘buy now, pay later’, which still encourages us to buy non-essential goods and services.

Start budgeting and find a way to live without credit.

Don’t be sucked in by points

Some New Zealanders like Airpoints or other rewards schemes on their credit cards. They figure that it’s free money
and flights.

The first fish hook is that these schemes come with an annual fee that has to be recouped before the points are of any value.

Then, if you miss paying your balance off in full once or twice in the year you’ve almost certainly paid for your own points.

The other catch is that even those people who pay their credit card bills in full end up spending more than they would have otherwise.

Academic research has shown time and again that we spend more with plastic than we do if we have to hand over cash. Our brains don’t like the latter at all.

It’s harder to track spending against a current account if you’re using a credit card, and also tempting to add “just this one little purchase”. We’ve all done it.

At least with EFTPOS or a debit card you’re only spending your own money, not going into debt.

Not even plastic

Our debit and credit cards aren’t even plastic any more. They’re invisible, says Hartmann.

We have the numbers pre-loaded into our favourite ecommerce sites, or know them off by heart, which is dangerous indeed.

Even emergency spending on credit cards isn’t great for people who want to be better with money.

Building up a small emergency fund that allows you to cover emergencies from savings means paying no interest at all.

Or, if it’s really necessary, there are lower interest ways of borrowing, including personal loans and, if appropriate, ‘buy now, pay later’ purchases limited to a few weeks.

Turn it to your advantage

Quit paying interest by kicking the balance-carrying habit. Put the interest you would pay into savings and watch it snowball in your favour.

With historically low interest rates, savers may need to invest in growth assets such as shares and funds rather than term deposits. Either way, what was once an interest payment can build real wealth.

Finally, think twice before refinancing credit-card debt onto the mortgage.

It’s a bad habit to get into because it disguises bad debt (consumer spending) as good debt (mortgage).

If you really have to refinance a credit-card balance onto the mortgage, make sure that portion of the debt is paid off over a five-year term, not 25 or 30 years.

Otherwise, it will end up costing you more. For example, $10,000 added to the mortgage at 4 per cent compounded daily will cost $12,213 over five years. Over 25 years, you’ll pay $27,181 in total on that $10,000 loan.

Finally, successful investors learn not to overspend in the first place.

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