Credit cards are evil minions

Once again, you might feel I’ve gone too far. “Evil Minions? Really?”

Well, in looking for an appropriate analogy for the destructive force credit cards have on many people’s lives, I only had to go as far as one of my favourite movies – Despicable Me 2.

One of the baddies finds that if he takes one of the yellow minions (who are completely loyal to the lead character Gru, even if they do sometimes create more chaos than they actually help), and adds his special purple serum then they turn into ... “an indestructible, mindless, killing machine!”

And that is pretty much how I feel about credit cards.

Indestructible ... yup.

Mindless ... seems so.

Killing machine ... well they frequently kill any possibility of getting ahead financially.

What I like about this analogy is that we stop thinking of our credit cards as pieces of plastic at our beck and call, and instead see them for what they are – evil minions designed to make us spend and spend and spend.

I’m not being cynical. This is what the credit card companies themselves would happily admit. They don’t make a dime if our cards sit idly by in our wallets, they only make money when we spend, and only make REAL money when we spend more than we can afford. Because when we are unable to pay off the balance each month, we end up paying interest.

Lots of it.

This is a very important lesson that I believe is worth spending a moment on. Credit card companies make the most money when we are unable to manage our credit cards well. When the card is maxed out, and we are only able to make the minimum repayment, they are making good money. When we then start going over limit and they hit us with an extra over limit fee EVERY MONTH, that is when they make super good money.

I don’t blame the companies – they don’t go and spend more money than they have and then spend the rest of their life paying things off. We do.

But this is their business, and they therefore will naturally do everything in their power to get us to that point by creating “freebies” that encourage us to spend. These include rewards points, free flights, cash-back and travel insurance if you pay with your credit card. These are all provided with the absolute knowledge that, in most cases, we will use the card and not pay everything off at the end of the month. And that knowledge is what makes them money.

For some of you, this will seem ridiculous, especially if you use a credit card and pay it off in full every month. It is merely an item of convenience, and never actually qualifies as debt as you never pay interest on it.

If that is you, please take a moment to give yourself a pat on the back. You are the one in a million of credit card users who manage to “beat the house”. In fact, you are exactly the type of person the credit card companies don’t want. Aside from an annual card fee, they make basically nothing from you. WOOHOO!!!

However, I imagine that for most of the people reading this book (and myself in my earlier years), credit cards have become a form of supplemental income. They fill the gap between what we actually earn and what we need to earn to spend the way we want to. They fund our Unrealistic Desires.

What I want to show you, without a shadow of a doubt, is that this is a one-way ticket to financial hell.

The following is not designed to be bank bashing or credit-card- company hating. When years ago, I managed to rack up more credit card debt than my annual salary, I did not blame the credit card companies. I placed that blame firmly at my own crazy-assed spending feet. However, I do think that by having our eyes opened to the fact that credit cards are designed to get us to spend more than we can afford, then perhaps the next time you pull out your credit card you will see it for the evil minion that it is, and put it back in your wallet.

Let’s run through the basics that make credit cards tick (like a time bomb), and the tricks we play on ourselves to disguise the fact that we are engaging in some pretty dangerous spending behaviour.

Myth 1: I just use my credit card for convenience

As mentioned above, this is only true for those of us who pay our credit card off every month in full.

If you are not paying your card off in full EVERY month, then your credit card is more than a convenience – it’s a loan. And a loan at the highest possible rate in the market. Aside from loans to bankrupt applicants, credit cards have the highest rates in the loan market, with the average card interest rate at about 20% per annum in Australia.

So, for every $100 you put on the card and don’t repay, you will pay $20 in interest, every year. Doesn’t sound too bad? Maybe that’s just the price of convenience, you think. Then try adding an extra zero – for every $1,000 you spend, you will pay $200 in interest, every year.

How about I put it another way: in the store you have two options; you can pay $110 in cash for a computer screen, or $100 via the in-store credit card. No brainer, right? You sign up for the in-store credit card and get the item for $100.

However, this is by far the worst option. Let’s say the interest rate on the card is 20% (and you should know that in-store credit cards, and other cards available through special promotions, often have higher-than-average interest rates). And let’s assume that I am the type of shopper who doesn’t pay her credit card off in full every month.

By paying cash you would have paid $110.

By using credit, after year one the item has cost you $120, due to the credit card interest of 20%. By year two it has cost you $144.

The point is you never would have agreed to buying that item for $144, so what the store did is tell you it cost $100, and ignore the fact that by putting it on the credit it will most likely cost you over $140. This is a great win for them, because we all think we have made a bargain and they make a massive mark-up on their item.

So, whether it’s an in-store card or a plain old credit card, for every $100 you think you are spending you are, in fact, spending upward of $120.

That doesn’t sound very “convenient” to me.

Myth 2: I am on top of my cards as I make the minimum repayment on time every month

Once again, kudos to you for paying your bills on time. This is something that some people can’t manage, which means they are lining the credit card companies’ pockets with overdue fees every month.

The thing you may not realise is that the minimum payment the credit card company quotes is not designed to help you pay them back – it is designed to earn them interest.

I had a fascinating conversation with some clients of mine who felt like they weren’t getting on top of their credit card debt. They had used cards to pay for their wedding, and had stopped using them after that. They understood they weren’t really to be used for the day-to-day, and therefore treated the debt on the card like any other loan they had, which was to make repayments as requested in the knowledge that, over time, the amount they owed would go down to zero.

However, they were frustrated that it seemed like the balance wasn’t reducing by much.

We had covered high interest rates on cards, but I wasn’t getting through. So I tried another angle.

“What term did you negotiate when you used the credit card?” I asked. They frowned at me, puzzled. “What I mean is that when you borrow money to buy a car, you agree how long the loan will be, say five years, and the payments are calculated to ensure you pay it off in that time.”

“So, what term was agreed with the credit card company?”

Of course there was no term. In fact, it is fair to say that a credit card is a loan that goes FOREVER. When the monthly statement states a monthly payment amount, this is not calculated to get you to zero, it is calculated to ensure you pay interest on the loan (as they would prefer if you didn’t pay off the balance at all).

My clients were horrified. They took the information on the statement as something that was a set-in-stone repayment calculation, and hadn’t taken into account that the group calculating it didn’t want them to pay extra.

Needless to say, they stopped focusing on the amount the monthly statement said they should pay, and instead came up with a period over which they wanted it gone entirely. We recalculated the monthly figure, and they paid that amount.

This is not unusual. Many of us take the information we are given as fact and do not question the intent of the party providing it.

Luckily in Australia some new legislation has been passed that requires credit card statements to show the user exactly how long they will take to pay off their credit card if they only make the minimum repayment. What is great about this is that, not only can people with a few thousand dollars of debt see that the minimum repayment could take over ten years to pay off, but they can also see the amount they will pay over that period.

Unfortunately we are all so conditioned to not read these statements in detail that many people miss that message, so I want to make it clear as crystal here.

Your credit card has a balance owing of $2,000. That doesn’t sound all that big, right? The minimum repayments are 2.5%, or $30, and the interest rate on the card is 20%.

By working my financial number-crunching magic, I can tell you that by making the minimum repayments:

• It will take you over ten years to pay the card off, and

• You will have made payments of $4,390.

Items that would have cost you $2,000 at the time of purchase have ended up costing you MORE THAN DOUBLE that. Think about that the next time you buy a load of items on sale with your credit card. Are you actually getting them cheaper?

I understand if this is a difficult topic, and it can be disheartening. My focus here is to highlight the problem for you – the solution is still to come.

I would also like to point out that if you have now realised that you are on the credit card train to nowhere, then you are amongst friends. The key thing is to acknowledge this and take action. We are Finance Action Heroes – we were BORN for action!

Myth 3: I got a great introductory rate on my balance transfer, I’m sorted

This is a difficult one as, if you are paying a lot of interest on your card, then instinctively it makes a lot of sense to reduce the interest you are paying. Shopping around for a card that will take over your current credit card balance and charge you less interest for a period of six or twelve months really does sound like an awesome idea.

And it is.

IF you pay the credit card off in that time.

The thing is, introductory rates on balance transfers are a clever way for credit card companies to find perfect customers. Well, perfect from their perspective. By offering you an introductory rate, you feel like you get a good deal, when in fact they were out looking for people exactly like you – people who have built up a balance on their credit card, and who are probably not paying it off in full every month.

This is perfect from their perspective, but not so much from yours.

The reason is that many people transfer their credit card balance thinking that this solves the problem. It doesn’t – it just moves its geographical location. The problem is still there – the behaviour hasn’t changed. If you are not paying down the debt then, after the introductory period finishes, you will have a similar level of debt on a high interest rate again.

So, if you have taken advantage of a low introductory interest rate to move across your credit card balance then well done for taking the FIRST step of TWO. Now you need to pay down extra on the card to make that effort really worthwhile.

Myth 4: I only use my card to get the rewards points

This is a very common response, and one I am guilty of, too.

Over a year ago I got offered a credit card that not only gave me a free domestic flight each year, but also gave me five double passes to premium cinema, venues around the country. And when I say premium, I mean individual recliner chairs, only 20 people in the cinema and food and drink (including alcohol) available throughout the movie.

For a massive movie buff like myself, there is no greater temptation.

So, I took the card offer up and got my free tickets. In the year since then, I have been to see a number of movies in luxury (although I paid over $40 for the food each time) and I have had my free domestic flight (although my annual fee is probably more than the cost of the flight).

So, all in all I have probably spent more than if I just went to the cinema in the normal seats, like I normally enjoy, and bought my own flight. Their cinema partner got more people to buy food in the luxury class, which is where they make all the money, and the credit card company has another cardholder.

Luckily I pay off my cards in full every month; however, it is only in taking stock of my own behaviour while I write this that I have realised that the sparkly, too-good-to-be-true offer that tempted me to get the card in the first place caused me to play right in to their hands.

I am cancelling the card tomorrow.

The thing is that most credit card rewards programs give you nowhere near that sort of value in the first year. They don’t give you vouchers or items just for getting the card; they only give you points for USING the card.

That’s not a surprise, of course, as the whole “rewards program” is another way to encourage you to buy something on your card rather than pay cash. They know that once something is on the card, there is a pretty good chance it won’t get paid off immediately and cha-ching! they have made some serious money.

If you have always felt that you got good value on your rewards points, then do a little tally for me:

• Note down the annual fee on your card;

• Estimate how much you spend on the card per annum;

• Calculate how many awards points that earns you a year; and

• Research what value you could get for those points.

In most cases, the annual fee far outweighs the rewards value. If I got you to include the interest you paid in the year by tallying up the interest on each monthly statement then, in almost all cases, the rewards card is costing you money.

I guess you could think of rewards points like free drinks at the casino. It is a “gift” designed to distract you from the incredibly large amount of money you are losing. In many cases, it can even help you lose more!

Myth 5: I need a credit card to buy things online

If you are falling back on this one, then I suggest you aren’t trying hard enough.

It is no longer necessary to have a credit card to buy things online. Not only can you generally use PayPal to pay for things online and deposit money directly in to your PayPal account, but there are also these super clever things called Visa Debit cards.

These have the same magical properties as credit cards, meaning they can be used to pay for things online; however, they are generally linked to a transaction account and the money is instantly withdrawn.

My husband and I use these almost exclusively when we travel.

Having saved a certain amount of spending money for our trip, we load up a debit card and then have great fun using it. It is so easy to log in and see where the money has gone and how much is left, and it is impossible to go over budget as a transaction is only authorised when there are enough funds in the account.

The even smarter currency debit cards actually convert your money into your foreign currency of choice, so there are even fewer surprises when you travel. You then know exactly how much local currency you have, so it’s easy to keep track of your spending. The only time you need to think about the conversion rate is when you want to work out whether the item is better value than at home.

You also don’t get hit with a conversion charge every time you pay in foreign currency.

No matter which way you choose to go, there is no excuse for having a credit card for online purchases. (But it was worth a try!).

Myth 6: I need a credit card for emergencies

This is perhaps a valid strategy if you get the card, and then don’t even put it in your wallet. It is there, just in case, for a random, unpredictable event.

However, the purchase of a shiny new something on sale is NOT an emergency. And this is often how the card ends up being used. Intentions start out well, however the convenience and simplicity of buying other items on the card is generally too strong a pull for most people to ignore.

Therefore, the danger of all of these myths is that very rarely does anybody leave the credit card for its intended use. If you do, well done. However, for those of us who are less disciplined, I believe a better technique would be to build up an emergency fund, and put in place some other emergency plans.

Myth 7: It’s just a bit of credit card debt, it’s no big deal

This is a really dangerous head space to be in.

If you look at the example I gave before, just a $2,000 debt on your credit card has you paying it off for over ten years, with the total amount you pay being over $4,000.

If we then make that debt $20,000 (which is nowhere near as bad as I have seen), the figures look like this:

• Initial minimum monthly repayment of $500, which

• Takes over 33 years to pay off, or

• $58,394 in total – nearly three times the value of the items you originally purchased!

That is a BIG deal.

33 years is the time it takes to pay a mortgage, not a credit card.

And it can get worse. If I managed to rack up $20,000 in credit card debt, then there is a good chance I am still spending more than I earn. However, now a whole lot of my regular earnings are going towards the minimum credit card payments. This gets uncomfortable, so what do I do? Get another credit card!

Before long your minimum repayments are the same amount as many mortgage payments, but rather than resulting in you owning a home, they result in you owning a range of clutter and trinkets you may not have needed in the first place. At least in the case of a mortgage you would have an asset – your home – that you could sell (or rent out for additional income) if the payments became unmanageable.

What could you rent out to help pay your credit card debt? Your TV? Unfortunately the items purchased on credit cards can almost never earn an income, and they are rarely worth even half what we paid for them in a sale, so the only way to pay down the debt is with our future earnings.

I used the example of $20,000 here as it isn’t so big that it seems ridiculous. However, I have seen many families on average incomes with credit card debts well over $50,000.

Rule of thumb – if you can buy a car with your credit card limit, the limit is TOO BIG.

But don’t freak out – we have a plan

First, let’s diagnose.

If you have credit cards, there are three possible scenarios you could find yourself in:

1. Paid off in FULL every month–queue the applause track, you are keeping those minions under control.

2. You haven’t increased your limits for some time, but the BALANCE ISN’T REDUCING quickly – you may have had
   a period of over-zealous spending, but while you have brought that under control, you aren’t making a dent in reducing the amount you owe.

3. You are coming up against your limits and will NEED TO INCREASE THE LIMIT or get another card soon – this is a bad state to be in as not only is your history costing you in terms of interest, you are clearly still continuing to spend more than you earn.

So, let’s start with those of you who wrote down Option 3. Unfortunately there isn’t a simple solution to this situation. In your case, you need to revisit all the previous rules – the ever-increasing credit card debt cycle is usually a symptom of a number of issues, each of which will need addressing.

The key is picking one and starting there. Perhaps it is getting on top of your needs versus your wants, or perhaps you are living a Ferrari lifestyle on a Ford income. Either way you are going to need to take action, and make it fast. Nothing will change unless you make the change.

However all hope is not lost – the first thing you can do right now is organise a debit card for your transaction account.

The second thing you can do is start using your debit card, and STOP using your credit cards. For the everyday, or even for major items, do your very best to stop using your credit cards at all. Aside from the benefit of stopping the increase in your credit card debt, you will start to notice when you used them most, and which behaviour was causing your over spending.

I had one client discover that over half his credit card debt was spent on going out drinking with the boys. When he started using cash instead of credit, he actually ended up having to walk home a couple of nights in a row as he had spent all his cash and therefore couldn’t afford a taxi to get him home. At that point, he figured that something probably needed to change.

Like I said above, in most cases just stopping isn’t easy – it’s a little like quitting smoking in that respect – however, the simple act of taking your credit cards out of your wallet and using them LESS is a super duper start.

So let’s imagine you have either managed to stop the credit card debt from increasing further (yeah you!), or you had already gotten to that point when you joined us here in Finance Action Hero land (i.e. you selected Option 2).

The next step is to set up a waterfall of cash.

Aaaahhhhh, doesn’t that sound good? Standing under a cascading waterfall of notes (not coins – that would be painful) that gleefully collect at your feet ... I told you things would get rosier.

Keep that image in mind, as it isn’t far from the truth.

The waterfall of cash plan of attack is:

1. List all of your credit cards - and I mean that literally, write each one down on a piece of paper (for the more techno- logically advanced, perhaps in a spread sheet).

2. Do some digging - next to each one, create three columns for the amount you owe, their annual interest rate and the minimum payment. Fill these in for each of your cards - you should be able to get all of these from your most recent statement.

3. Reorder the cards - prioritise the cards with the highest interest rate at the top, down to the lowest interest rate at the bottom.

4. Do your sums - add up the minimum repayment amounts for the next month.

5. Pick your payment - take the total repayment figure from above, and pick a figure higher than that. This is a fixed dollar amount that you are now committing to apply to reducing your credit card debt until it is gone. While it needs to be higher than the minimum repayment amounts, it is important that you are able to live day-to-day with this figure. If it is too big, you will give up after one month, but if it is too small, you won’t make a dent in your debt.

6. Get paying - when your next payments are due, make the minimum repayments on the cards at the bottom of the list. When you come to the card at the top of the list, use whatever is left from the total amount you set to pay down that card.

7. Knock off the first one - keep doing this until the card at the top is paid off. Preferably cancel it the next day.

8. Keep going - continue to make the minimum repayments on the cards at the bottom of the list, with the card that was in second place getting whatever is left over from your total monthly figure.

9. Going, going, GONE - repeat this until all the cards are paid off and gone.

The key element to this working is to never reduce the total monthly amount you repay. Even while your credit card balances start to drop, stay committed to that monthly repayment amount and you will really start to see some results.

Why is this a waterfall? Well as the top card is paid off, more money becomes available to pay off the second one. And as the second one is paid off more is available for the third. Then, magically, once they are all paid off, all that money will start piling up at your feet.

This probably feels too basic to be effective; however, let me tell you why it works.

Your minimum repayment is often set as a percentage of your debt, so if you only make the minimum repayment, when your debt drops, your minimum repayment will drop too.

The beauty of waterfall of cash method is that, as you reduce your debt, your total repayments remain the same. So you keep hacking away at that balance. The double whammy is that as your balance drops, the amount of interest you have to pay drops, so more of your monthly repayments end up reducing the balance rather than just repaying the interest, and your momentum increases with every card you pay off.

I promise you, once you start this method it won’t take long before you see it really humming. And the satisfaction of actually paying off that first card will give you such a buzz there is every chance you will attack the next ones with even more glee.

The only important thing to do from then on is to never get in to that situation again. You have broken free of credit cards and their evil hold on you, so please make sure you don’t end up there again.