There are two very different camps when it comes to credit cards. There are those who believe they should be avoided at all costs, and there are others who believe that credit cards can be a great budgeting tool.
Both sides can be correct, but it all depends on the holder of the credit card and how they use it.
There is no doubt that credit cards get thousands of Australians into financial difficulty every year. For those of us without sufficient financial discipline, credit cards can quickly spiral out of control and leave us in a serious debt trap that may seem impossible to escape.
But when used properly, credit cards can not only be a convenient and useful budgeting tool, they can even help you to reduce your home loan.
Getting the basics right
Before you even think about using your credit card effectively you need to make sure you have the right card to suit your needs.
If you plan on repaying your card in full each month, then you’ll want a card with an interest free period. The longer the interest free period you can get the better, especially if you plan on using the card as part of your mortgage reduction strategy.
If you plan on carrying a balance on your card from one month to the next and not repaying it in full, then first of all you need to take a look at your overall financial situation and decide whether or not a credit card is even right for you.
If you fit within the latter category but still wish to use a credit card, then you can choose a card without an interest free period since you’ll always be charged interest anyway. Generally you can obtain a lower interest rate when selecting a credit card without an interest free period.
Pay off the balance
If possible, it is always best to repay the balance in full at the end of each monthly billing period.
For cards with an interest free period, you will be assured of never paying any interest provided that you clear the balance each month.
If you cannot repay the balance, then you should try to pay as much off the balance as you can in order to keep your interest charges to a minimum.
Remember, if you do not repay the full balance you will be charged interest. In some cases the interest will be backdated to the date of purchase, even if you have a card with interest free days.
Budgeting using credit cards
Because credit card statements contain detailed information about every transaction you make each month, they can be a great way of keeping track of your spending and assisting with budgeting.
At the end of each month you can sit down with your credit card statement to see where you money is being spent and identify any areas where you can cut back. This is not something you can do with cash unless you keep detailed manual records.
Low rate balance transfers
Banks and other financial institutions often offer credit cards with low rate or even zero rate balance transfers. If you carry a balance on your credit card from month to month, it may be worth considering a balance transfer in order to secure a lower rate.
Because you will be charged lower interest rate, more of each month’s payment will come off your balance rather than just covering the interest. This can allow you to repay your credit card debt sooner.
Most offers will be for a special rate over a limited time, for example 2.9% for six months. Others may offer a slightly higher interest rate but over a longer period, for example 3.9% over twelve months.
As for which is better, it depends on your own personal circumstances. If you think you can repay the full balance within six months, then the first option may be the best. But if you think it will take twelve months or longer to repay, the latter option may be better.
The reason the banks offer low rate balance transfers is to attract new credit card clients, but there are a few catches to watch out for.
Often once the balance transfer period ends, the rate will jump up to a much higher rate. If you have not repaid the balance in full by this time, you could find yourself paying more interest than you were on the original card you transferred from.
It is also important to be careful when making additional purchases using a balance transfer card, as any repayment you make will often come off the low rate portion rather than the latest purchase, meaning that your purchases could sit on your card for years at the higher rate of interest whilst you keep paying off the balance transfer portion at the lower rate.
Not all cards work in this way, but many do so it is important to check the fine print before taking out a balance transfer card and making additional purchases using the card.
Using credit cards to reduce your home loan
Credit cards with an interest free period can be used in conjunction with a mortgage offset account to help repay your home loan sooner.
This strategy requires you to put all of your income and wages into your mortgage offset account, whilst using your credit card to cover all expenses. At the end of each billing cycle the credit card balance must be paid in full using funds from the offset account.
The strategy works by maximising the balance in your offset account throughout the month, which reduces the interest you pay on the mortgage. No interest is payable on the credit card because the balance is cleared by the due date each month.
Credit cards – friend or foe?
Whether your credit card has a positive or a negative impact on your financial position really depends on how you use the card. Use the card effectively and it can definitely have a positive effect, but using your card in the wrong way can have a major and lasting negative impacts.
About Shane MooreShane is a former financial adviser who has been in the finance and insurance industry for over a decade. Shane holds numerous industry qualifications and is a Senior Associate of the Australian and New Zealand Institute of Insurance and Finance.
