Credit and store cards are a very easy source of credit but they are also very expensive. It is therefore not surprising their careless use cause so many debt problems.
Easy Credit and High Interest Rates Make Convenience Dangerous
There is a vicious circle here. The high interest rates make indiscriminate credit card debts difficult to repay. As a result default is increased and so requires lenders to charge higher interest. The high interest rates make the debt more difficult to repay and increases default. The linked article on compound interest and setting of interest rates explains why.
Credit and Store Cards – Easy but Expensive Credit
Credit and store cards provide easy but very expensive credit – even though central bank interest rates are at the lowest for a generation, at less than 1%, credit card interest rates are typically between 15 and 35%. Hence the recent criticisms in the press and by politicians that credit card companies are profiteering. However in financial down turns the default rate goes up and those losses may have to be recovered through increased charges.
Where a purchase has to be made on credit then a cheaper bank loan will be much more sensible and should be matched to the life of the purpose. If the borrower cannot get a bank loan and credit cards are the only available source of credit then arguably they should not be making the purchase. It is likely they may struggle to repay it; at least their bank would appear to think they may struggle.
Do Not Use Credit Cards as a Source of Credit for Everyday Expenditure
As is described in the linked article matching loan to purchase life, credit should only be used for assets where there is a long term benefit. Everyday expenditure does not qualify on this basis and should not be funded with credit. Using credit cards to fund everyday items will only make paying for those items more difficult in the future. Eventually credit will dry up and the accumulating interest and living costs will have to be paid for out of current income with consequent impact on lifestyle and health.
Interest Free Periods are Not What They Seem
Credit card users often assume they pay no interest on a purchase for a grace period of up to 56 days. Such grace periods are based on a purchase being made immediately after a bill is issued and assumes a full month plus the 25 day payment period. However that interest fee period is a maximum and only applies if the card bill is paid in full. If the outstanding amount is not cleared the interest is charged on the full purchase cost back to the time of purchase.
Anyone with a credit card would be well advised to set up a direct debit or other automated payment to pay the monthly bill in full so avoiding the high interest and getting the benefit of the interest free period.
Use Credit Cards as a Means of Payment Not as a Loan
If the credit card is being paid off in full each month then a charge card may be more appropriate. However the card user should check the terms and conditions carefully as charge cards may not provide the same level of fraud and purchase protection – it will be in the terms and conditions. In the United Kingdom the user of a UK credit card, not charge or debit cards, has legislative rights protecting them under Section 75 of the Consumer Credit Act. Charge cards will depend on the issuer taking an enlightened view and providing similar protection in their small print.
Is There Any Point in Credit Cards?
It can be argued that there is very little reason to have a credit or store card and then not really as a source of credit. There is some benefit from the payment protection, convenient form of payment and plastic cards may have some use in an emergency. However it makes sense only where the funds are not immediately available but can be released to pay the bill in full at the end of the month.
Cigarettes and soon probablydrink will come with a health warning, so perhaps should credit cards. Using credit cards wisely requires self-discipline.
First seen on Suite101