This article was published on 16 July 2011. Some information may be out of date.

Cries of indignation, shock and fear from Credit Card Land

Three readers coming from three quite different perspectives responded to my last column about repaying credit card debt. One slightly indignant reader always pays his credit card bills in full, another was shocked at what happened when he didn’t one month, and the third has run up a $7000 credit card debt.

The column said some people can, in effect, make a risk-free investment that returns just under 20 per cent. That’s because repaying credit card debt with a 19.95 per cent interest rate improves your wealth as much as such an investment would.

The first reader, who always pays in full, thought the column was misleading. “I suggest that if I didn’t pay on the due date it would cost me 20 per cent. The fact that I don’t do that doesn’t earn me 20 per cent,” he wrote.

He’s quite right, of course. But I took care to say, “I may be able” to get you a 20 per cent investment. Perhaps I should have spelt out that I wasn’t including people who make full payment each time, but I would have thought that was obvious. Stiil, I’m sorry if I raised false hopes.

The second reader wrote that just once he forgot to pay his credit card, and “I was shocked at the amount of interest charged, called the bank and was told that they charge interest on a day-to-day basis.

“So I sat down using the standard compound interest formula, and lo and behold the actual annual interest rate was over 35 per cent! I wonder how many people are aware of that figure?”

I suspect quite a few aren’t. Being just a day late is really expensive in Credit Card Land.

A good way to avoid forgetting to pay your credit card bill is to set up a direct debit from your bank account. This will take place on the due date, letting you earn as much interest as possible on the money in the meantime.

But, as Consumer NZ notes, “make sure that you have enough in your bank to pay it. Raewyn Fox, the CEO of the NZ Federation of Family Budgeting Services, told us that they often heard of people getting hit with steep penalties for defaulting on their direct debits.”

Our third reader — the one with $7000 of credit card debt — says she seriously wants to get rid of the debt, and expects to be able to do so over two years.

Her two cards charge “low” interest rates. “But I am wondering if it would be better to get a personal loan and pay off the credit card debt and close the credit cards,” she writes. “I’m scared I will continue to use the credit cards while I pay them off.”

If the interest rate on the personal loan would be lower than on the cards, that’s your better choice. And it does remove temptation.

But if the interest is higher, it would be better to stick with the card debt and cut up your cards. Or, if you want to keep one card for emergencies, freeze it in an ice tray of water so you have to go to some trouble to get at it — giving you time to reconsider.

One more point from Consumer NZ: “Minimum payments are designed to benefit the bank — not you. A $4000 debt on a card charging 19.95 per cent could cost you $19,400 in interest and annual card fees to repay if you’re only making minimum payments. It’ll take you 60 years to pay off this debt.”

Those costs are almost five times as much as the original purchases. Wow.

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Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it.