I met a prospect a few years ago. He is of about the same age as me. After some fact-finding and discussions with him, I came to know that he had about RM20k worth of credit card debt. In fact, he had started with a negative net worth. I was then curious to know how he dug himself into such a big debt hole.
He said an experienced elderly person told him that all the while we put our money in the bank and let the bank use our money. However, with a credit card, it is akin to the bank giving us money to spend. He added that people with credit cards should therefore maximize this until the limit is reached. He proclaimed, “How wonderful it is to own a credit card!”
How credit card works?
A credit card is a thin, plastic card usually 3 1/8 inches by 2 1/8 inches in size. This plastic card contains identification, either in the form of a picture or a signature. It authorizes the person named in the card to charge his or her purchases or services to an account, for which charges will be billed monthly. Information on the card can now be entered online to make online purchases or at ATMs to withdraw cash. When a person signs for a purchase using his or her credit card, the issuer is in effect, lending money to the consumer or the user of the card to be paid to the merchant providing the goods or services.
Each month, the credit card user is sent a statement that would indicate the purchases undertaken with the card, any outstanding fees, and the total amount owed. After receiving the statement, the cardholder can dispute any incorrect or inaccurate charges. In a typical situation, the card owner would be required to pay a defined minimum proportion of the bill by a specified due date. The card owner can also choose to pay a higher amount up to the total amount that is owed. The credit provider will typically charge interests on the amount outstanding.
Pros and Cons of using Credit Cards
- Convenient to carry
- Safer than carrying around a stack of cash
- Handy during emergency
- If you pay on time, it will help to build up a reputable credit record
- Most credit card can be used worldwide
- Get redeemable points, rebates, freebies and goodies
- Serve as a source of short term loan – might be interest free for 20 days at least
- Enjoy the advantages of e-commerce
- Fraud cases
- Can be stolen
- Penalties for late payment
- High interest charges – as high as 18% p.a. if you can’t afford to pay in full
- Misuse will lead to poor credit history
- Annual fees for the credit card service
How credit card digs your debt hole
Buy now, pay later
Using a credit card or just having it in hand is so convenient for users. This is risky because some may tend to spend recklessly without realizing that they have overspent. They only realize it when they get their monthly statement and find that they have insufficient funds to pay the full amount.
Cash advance has no interest-free period
You can withdraw cash from your credit card via any ATM machine if you have the 4-digit pin. Interest charges are calculated immediately. There is no grace period allowed. Moreover, there are fees involved to withdraw cash advance. According to a recent study in UK, it is estimated that over one million people are using cash advances to cover mortgage and loan and payments.
Making minimum payment
Using your credit card means that you will have to spend your future money to settle the bill. Future money is the money that is not yet earned by you, but you think you can earn it if you continue to work in the future. When you make a minimum payment, you will be borrowing money from your future earning. You are making the commitment that you will be able to pay back the amount you are borrowing for your current expenses.
Snowball your credit card debt till the minimum payment is no longer affordable
Some people get an additional credit card when they have reached their limit for the existing one. If you still paying a minimum amount every month, the debt is going to snowball into a bigger debt. When it reaches a situation where you cannot even afford to pay the minimum amount, you will start to receive legal letters. Finally, you might end up in bankruptcy.
How to make money from your credit card
Also buy now, pay later – it is a regular borrowing for free!
Let’s say that your monthly fixed expenses that can be paid using your credit card are RM5000. When your bank issues your credit card statement, they typically give you 20 days interest free period that starts from the date reflected in the statement. Now imagine that you already have the RM5000 required. You can keep it to yourself at least for 20 days. In other words, you get interest returns on your money. It is akin to having an extra RM5000 in your bank every month with this amount earning you interest returns. If you put this amount in a fixed deposit, it will earn you RM200 per annum on 4% return.
In other words, if you use cash to pay for all those fixed monthly expenses, you will have less money in the bank that can “work” for you positively.
Photo by lwr
Delaying big purchases until the statement date
If you pay some massive bills just after the statement date, you have as long as 50 days to keep the money to yourself, and only pay for it just before the due date. Suppose you want to buy a new PDA, which costs RM2000, delay it and only pay it on your credit card statement date. You will have 50 days interest free period.
A credit card is convenient to carry and use because it eliminates the need to carry a substantial amount of cash around. This is especially so if you are paying for items worth more than hundreds of dollars. However, I would prefer using a credit card rather than cash, even if the item were as cheap as RM2.50. This way, you will be able to save your trips to the ATM machines. If we can pay anything using credit card, it would be a cashless world where we save both time and also money.
Credit Card statement help to track your expenses
Instead of manually keeping track of all your expenses, using a credit card actually records all your expenditure. This helps make our life easier. You will save a lot of time and money doing bookkeeping.
Zero-interest installment purchase plan
Some merchants collaborate with credit card companies to provide affordable installment plans for certain purchase. For instance, Dell computer gives a purchaser a choice to opt for zero-interest installment payment if you possess a Maybank credit card.
Instead of paying for the item in a lump sum, you can keep the money to yourself, and only pay the monthly installment. That’s beneficial to you. You still have the large portion of money that was supposed to be given away for the purchase. At the same time, you are able to enjoy the new purchase.
Freebies, Goodies and reward points
Credit card companies offer all kinds of freebies and goodies:
- Giveaway gifts for signing up and applying for a new credit card
- Monthly contest, where a few users will be selected as winners for all kind of prizes including TV, vehicles, gadgets etc
- Reward points are given for every dollar spent. This can be used to redeem gifts, and even cash rebates
Always ask for annual fee exemption
You can either use a free-for-life credit card, which doesn’t charge any annual fees, or ask for an annual fee exemption every year. I always call the customer service centre to ask for an annual fee refund. Each time, I succeed because I am a loyal customer of the card. If you use their card, they are willing to cancel the annual fees. Don’t ever blindly pay the annual fees. It is not worth it.
Always pay the full amount on time
It is pretty easy to do this. You can either
- wait until the due date to pay by cash, or
- one day earlier using check payment, or
- key in your credit payment using online banking service and schedule it (post-date) to the due date
You must ensure there are no outstanding balances on your credit card at all times.
How to eliminate credit card debt
Photo by danesparza
Gather all your credit cards info – bank, amount due, credit limit, interest rate, customer service number
Ask for interest rate reduction
Ask for no fee transfer
Ask for any counter offer
If you fail the first time, call again. Maybe the second representative is kinder
Ask to speak to the supervisor or manager
Sort from highest to lowest interest rate
Transfer from the highest interest cards to the lowest
Ask to increase credit limit if the lowest interest rate card’s limit is reached
Pay minimum balance on other card, but as much as possible on the highest interest rate card
Snowballing effect – after paying off the highest one, pay as much as possible on the second highest. This time got more fund because you are adding up the minimum payment previously. That’s why we call it snowballing!
Read the nice illustration by Moolanomy
Alternative financial resources that can help you eliminate your credit card debt
Photo by gak
Insurance cash value
This involves depending on your insurance policies. The bonus on your policies can be withdrawn because it only gives you 5% interest if it is left in the policy. After withdrawing the entire bonus, apply for a policy loan which charges 7% daily for the rest of the amount (applicable for traditional policy only). Take the loan from your life insurance policy. If it is an investment-linked policy, you can redeem your investment unit. Please note that I am not advising you to lapse or surrender your policy. Just take the money to pay your credit card debt should such a situation emerge.
Later when you have more surplus, you can pay back your policy loan.
Home loan refinancing
Mortgage is the cheapest loan. Refinance your mortgage, either to a larger sum, or prolong the term with lower installments per month. It is better to refinance for a higher amount because you can pay off your credit card debt straightaway. If not, try to prolong the term. You will get better cash flow to pay off credit card.
Micro loan from family, relatives and friends
Borrow a small sum from your friends, family or relatives and offer them a higher interest rate than a fixed deposit. If you offer 10% return, they are most likely to help you with the money you need. If you feel ashamed, just make up some reasons that you need the money for short term. You can also say that your investments are tied up and that you don’t want to liquidate them.
Some people opt to cut their credit card in fear of misuse. If you are able to apply the tricks discussed here, I guarantee that you won’t be a credit card slave. Credit card is a very useful financial invention of this modern world. People love to have their platinum card in shown off when they take out their wallet. Besides letting you pay your expenses, it is also a symbol of high income earner. If there are balance not being paid off in your credit card, by all means settle this debt first before thinking of doing any investment. You can’t beat 18% annual return unless you are doing a business.
Turn credit card from being a foe to becoming a friend.
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This article was first Published on 25th Feb 2008, updated on 9th April 2009. You will also find this article included in a chapter of my published book – Top Money Tips for Malaysians.