Just as with smoking: never start.
When I was twenty years old I decided it was time to get a credit card. I filled out the form at the bank and requested a $500 limit. Ten days later I was happily surprised to receive a MasterCard with a $1,000 limit. Their welcome letter told me about all the wondrous benefits and freedom from having a credit card. The bank clearly thought I was a rock-star with an incredible ability to repay them anything they advanced me on this wonderful card, despite my $12,000 annual salary. I was so proud of myself, and absolutely resolute that it would be, as I had convinced myself before I applied for the card, for emergencies only.
Very soon I was wearing my new “emergency” leather jacket, my new “emergency” Bollé sunglasses, my new “emergency” shoes and listening to cassette tapes on my new “emergency” car stereo. Even better, all I had to repay was 2% of the outstanding balance every month. What kind of magic money fountain had I been given? I could even get cash advances from an ATM. Sweet!
The interest charged was massive. Even though I was paying their minimum amount, each month I seemed to have more debt. I hit my limit. The bank started sending letters that seemed to have changed in tone from the welcome letter I’d received. You could say they became demanding. I had to get my card down below the limit, but on my meagre twelve grand a year how was I going to manage that? Eventually the bank granted me a lifeline: they increased my credit limit! You can probably see what happened next: new tyres, a new suit, a gift for my girlfriend… Now I owed $2,000.
I’d fallen for the credit card trap. It’s easy to spend the bank’s money but much harder to repay it. And that’s what the bank wants. They are borrowing money at around 3% and lending it to you at around 20%. They want you to be at your limit and to make only the minimum repayment. They entice you with interest free periods, points schemes, flashy marketing to make you feel special, tap-and-go payments and access to a range of “benefits” you’ll probably never use.
There are a number of dangers to avoid with credit cards. Here’s just a few
- low, or zero, introductory interest rates: you sign up on the cheap and before long you’re hit with a big increase you can’t afford
- cash advances: there’s no interest-free period on a cash advance
- paying the minimum payment: this payment is just above the interest you’ve accrued so you never really get ahead of what you owe. Banks are now required to tell you how long it will take to clear your debt by paying the minimum. It can be 30 years or more
Credit cards can be useful if you can pay them in full every month. If you don’t have the capacity to do that, some good advice is to steer clear of credit cards. Think about how they work and then consider how the bank entices you to get one. Much like cigarettes, with credit cards once you start you’re likely to get hooked. And that’s just what the bank wants.
Categories: Small change