Today, much of society appears comfortable with the idea of living on credit. It is even seen in some eyes as a “necessity”. Quite often, those who utilise credit cards and services such as after pay are quick to point out “oh, but I always pay it off eventually.” What this cultural trend highlights though is our need for instant gratification. This is neatly summed up by Cornelius J, Author of the Credit Repair book who said ‘Companies capitalize off people’s unwillingness to patiently wait… Top companies understand this demand and respond, “No problem, I will give it to you now, but you will have to pay.”’
And pay the price we often do. The one who hugs a debt also shakes hand with a danger. Taking on or utilising credit is a liability and liabilities are debts. Debts are a danger. Yes, we have discussed “good debts” in the past – where we use debt funding to “step up” to the next level of our wealth portfolio, or enter a new market (such as property ownership) – but ultimately holding long term debt reduces your net worth. Plus, the interest you pay on debt is money that cannot be saved or invested—you are literally throwing it away for the privilege of owning something now rather than saving towards it.
If credit is not used wisely, debt can easily get out of hand. This opens the door to a slew of other nasties and the late payment fees which you are slugged with are just the beginning. Here are my 10 reasons why you should be avoiding credit cards at all cost:
- They can damage your credit score.
This is the one where most people come undone, especially the younger generation. They are often told “you need to have a credit card to show that you can pay back credits or loans. It is favourable for your credit rating’’ – even the banks will sprout this line of thinking. Only a small portion of your credit score is actually attached to your utilisation of credit. What will hurt you more is missing payments, the number of credit applications you have made and the credit limit or size of the debt you are in.
- They can come with universal default.
Once you start defaulting on payments you know you are in trouble. Not only are you putting yourself under financial stress, but the credit card companies can and will increase the interest rate they charge you as a penalty, adding more financial pressure and adding to the debt.
- They charge huge interest rates.
Banking is a business, and credit cards are a profitable aspect of their offering. The lending standards for credit cards are not as strict as other types of loans, putting the credit issuer at higher risk which is how they justify the “pricing” of these cards.
- They come with numerous fees.
Let’s talk fees – cash advance fees, international transaction fees and the dreaded late fee. These can quickly add up. Example: A credit card with a $1,000 limit with an 18% interest rate will accrue $861 in interest if only minimum payments are made. If you add one month’s late fee and make your principal $1,020 you will have to pay out $937 in interest if you only make minimum payments until the card is paid off. That $20 just cost you $76.
- The fine print is not designed to favour the borrower.
Many people opt out of reading the fine print in their credit card contracts, cited as too long or hard to understand. This is where bill shock eventuates as those fees and charges we know nothing about are hidden in the contract we signed. In addition to the fees mentioned, borrowers get caught out not knowing what happens after their introductory interest rates expire, how and when rates are likely to be increased and how “fixed” that rate you applied for really is.
- They have deceiving minimum payments.
Making minimum payments and thinking that you have your credit card under control? Think again – the minimum will in no way get you across the line unscathed when it comes to the interest you will end up paying. All credit card statements must clearly state how long it will take you to pay off your card if you just pay the minimum and most importantly, and how much interest you will have to pay. A credit card limit of $5,000 at 18% will take you 33 years to pay off at the minimum and cost you a whopping $12,181 in interest! The government has a calculator where you can play with these numbers and see what the privilege of having a credit card could end up costing you:
- They encourage impulse purchases.
This is a big one for me. It is about money mindset and to build wealth you have to put into practice healthy money management skills. This does not mean whipping out the credit card as soon as you see a new pair of shoes you feel you just have to have, without thought to how you are paying for them or ultimately, what they are really costing you.
- They increase your spending.
In addition to encouraging impulsive purchasing you will ultimately end up buying more of what you don’t really need simply because the funds appear to be on hand. Credit Cards are not productive to reigning in spending habits and are really not going to help you do so. If you can’t tighten your discretionary spending it is you who will suffer in the long run as the money you could have saved could have been diverted to more appropriate and meaningful goals such as investing.
- They encourage you to spend more money than you have.
If you can’t afford it, you shouldn’t buy it. Simple.
- Credit cards will bait and switch.
The credit card company rewards you for making your minimum payments with what appears to be an offer for a preapproved 0% fixed-rate credit card application. You assume that when you fill out all the information, you will receive a 0% fixed-rate credit card. What may very well happen is that you will receive an alternative card that has a higher interest rate. Some credit card companies write in the fine print that by filling out the application, you agree to take whichever of their credit cards they decide to send you and not specifically the one that they are advertising. ASIC is onto this and are cracking down on the advertising strategies employed by credit card companies, particularly where the word “free” is involved.