Credit cards can often seem like an easy solution to that all-too-common problem; too many bills and not enough money. Then Christmas comes around before we know it and your credit card seems like the only way you can buy those must-have gifts. The same can be said for birthdays and other special occasions, and on top of all that there are also unexpected expenses like car repairs and appliance breakdowns to pay for. At times like these, when your monthly income is already accounted for with the usual expenses, and you need that extra help, your credit card can seem like the perfect answer. But is a credit card really the answer or is it adding to your financial problems?
It can be tough for a family who suddenly need to buy a new washing machine but don’t have the spare £200. Monthly payments of £20 or £10 would be much more manageable, but they may not realise they will be paying a sizeable amount in interest. Some people pay off their credit card balance in full every month, and in that situation they would not be paying any interest. But if you have a balance on your credit card and you take a look at your statement you may be surprised by how much of your debt is actually interest that has accrued.
Recent information from Moneyfacts has revealed that credit card debt has increased, and the average Annual Percentage Rate (APR) is now reaching 23.1% (June, 2018). There has been a 1% increase in interest rates on credit cards provided by Lloyds Bank, HSBC, Halifax and Bank of Scotland. What is even more concerning is that while interest rates are rising, there are many customers having difficulties repaying their existing credit card debts. In the first three months of 2018 alone, credit card providers had written off a total of £318 million. In this instance, the company sells the debt but the customer is still required to repay it.
The problem with Minimum Payments
Everyone knows that all spending on your plastic adds to the bill and the debt increases. A common mistake amongst credit card users is to make the minimum monthly repayments towards the bill. However, each time you make the only minimum payment to your bill, the interest is adding up and your debt continues to rise. Even if you stop spending on your credit card completely, it could take you years to clear your debt by making only the minimum payments. This is due to the large amount of interest you would be adding to the debt.
How Minimum Payments are Calculated
Minimum payments are calculated by taking a percentage of the total balance. It is typically around two percent, or £5, whichever is higher. But this can vary depending on the credit card. Bear in mind that the minimum payment goes towards the interest and the amount that you originally borrowed. For example, with the £200 washing machine the minimum payment would usually be around £5 per month, and this sounds ideal to many people. Such a low minimum payment may seem insignificant, but on a typical 23.1% APR credit card it would take over two years to repay and cost over £100 in added interest. That’s more than half of the cost of the washing machine in interest alone.
Attractive offers such as 0% interest offers for a limited time period, can be hard to resist. While this sounds great, it can end with a large interest fee being added to your bill if you don’t completely pay off your full balance before the the end of the limited time period. This is another lesson many credit card customers have learned the hard way. When you first take out the card you’re effectively borrowing for free as there is no interest. For many people, it is easy to get carried away and build up quite a balance, with a mindset that all you need to do is repay the balance before the 0% interest runs out. But that date fast approaches, and before you know it you are struggling to find the money to repay the full amount in time. Once interest charges are added to the account it can be difficult to repay the debt in full.
You might think you would use a new credit card for a one off purchase then repay the balance, but once that plastic is available the temptation to use it is usually powerful; especially when the bills come in. This is a situation that is all too common with many credit card users. Using the card to fill a financial deficit between your income and your expenses can quickly result in a large debt. Once your bill reaches a significant amount, and you are still faced with your usual monthly outgoings it can be very difficult to find enough money to pay more than the minimum monthly payment. The combination of a high interest rate, an increasing debt, and low monthly repayments can quickly descend into financial chaos.
If you find yourself in this position with a spiralling credit card debt, there may be other financial options available to you. For example you may benefit from paying the credit card debt off with a loan. Talking to an advisor who can discuss loan options with you is a good idea as they may be able to offer you a better interest rate. Additionally, with a loan you could also repay your debt quicker, making affordable monthly repayments that you and your lender agree on. If you do not have a credit card, but you are thinking about your financial options for some upcoming expenses, you should bear in mind the potential financial risks involved with credit cards and carefully consider other financial borrowing choices.
Credit cards are considered a popular way to manage borrowing and spread the cost of large expenses. However this is just a short-term solution that only gives the customer some extra time to repay the debt. Customers should be extremely diligent, as a growing credit card debt may overwhelm them and eventually cause a large dent in their finances.