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Credit cards, don't get stung

Credit cards - don't get stung

There’s no denying that credit cards make life a hell of a lot easier, but the banks seem intent on making us pay for the convenience by charging unreasonably high credit card interest rates.

Interest rates on most banking products – such as home loans, savings accounts and term deposits – have come down in line with reductions to the cash rate by the Reserve Bank of Australia, but not so for interest rates charged on credit card purchases. According to RateCity chief executive Damian Smith, Australia’s major banks are charging a 25 percent interest rate premium on credit cards – costing the average consumer $600 extra per year, and depositing $120 million a month in banks’ coffers.

The average credit card rate is currently around 16.67 percent, but would be 12.68 percent had the banks passed on RBA rate cuts over the past five years. While they failed to pass on recent rate cuts (with the exception of National Australia Bank, which dropped the rate on its Low Rate Visa Card by 25 basis points on January 9), the big four banks all raised their rates when the RBA last raised rates in November 2010.

“The only thing that may change the banks’ behaviour is if a large number of consumers switch from credit cards with high interest rates to low-rate cards,” Smith said.

A dose of healthy competition may also do the trick. “Credit card spending has definitely slowed in the past two years and if that keeps up, banks may have to respond by lowering fees or lowering interest rates.”

In the meantime, there are things you can do to ensure you get a better deal. The first tip, according to Smith, is to ensure you have the best card for the way to spend and make repayments. “There are plenty of people with cards with a high interest rate because they offer rewards, but you have to spend a lot to enjoy any benefits.”

In fact, when you factor in the annual fee, you’ll need to spend $60,000 in one year to see any benefit from rewards cards. When evaluating which credit card is best for you, take a look at the headline rate, annual and ongoing fees, and the number of interest-free days.

The most helpful tip is to ensure you pay more than the minimum repayment required. “More than two million people only repay the minimum, which is a risky strategy,” Smith said. “A $5000 debt repaid at the minimum 2 percent per month will take you nearly 30 years to repay.”

Inertia is the biggest factor holding people back from switching to a more suitable credit card, Smith added. “You can end up paying hundreds of dollars a year more than you have to by not switching to a better card. Of all the financial products, they’re just about the easiest to switch – an hour of your time now can save you $500 this year.”

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Learn more about credit cards

Can a pensioner get a credit card?

It is possible to get a credit card as a pensioner. There are some factors to keep in mind, including:

  • Annual income. Look for credit cards with minimum annual income requirements you can meet. 
  • Annual fees. If high fees are a concern for you, opt for a card with a low or $0 annual fee. 
  • Interest rate. Make sure you won’t have any nasty surprises on your credit card bill. Compare cards with a low interest rates to minimise risk.

How does credit card interest work?

Generally, when we talk about credit card interest, we mean the purchase interest rate, which is the interest charged on purchases you make with your credit card.

If you don’t pay your full balance each month (or even if you pay the minimum amount), you are charged interest on all the outstanding transactions and the remaining balance. However, interest is also charged on cash advances, balance transfers, special rate offers and, in some cases, even the fees charged by the company.

The interest rate can vary, depending on the credit card. Some have an interest-free period, otherwise you start paying interest from the day you make a purchase or from the day your monthly statement is issued. So avoid interest by paying the full amount promptly.

How to calculate credit card interest

Credit card interest can quickly turn a manageable balance into unmovable debt. So being able to understand how interest rates translate into dollars is an important skill to acquire.

The common mistake people make is focusing on the credit card’s annual percentage rate (APR), which often sits between 15 and 20 per cent. While the APR does provide a rough idea of how much interest you’ll pay, it’s not entirely accurate.

This is because you actually accrue interest on your balance daily, not annually. So, you need to work out your daily periodic rate (DPR). To do this, divide your card’s APR by the number of days in a year (e.g. 16.9 per cent divided by 365, or 0.05 per cent). You can then apply this figure to the daily balance on your credit card.

How do you use a credit card?

Credit cards are a quick and convenient way to pay for items in store, online or over the phone. You can use a credit card as a cashless way to pay for goods or services, both locally and overseas. You can also use a credit card to make a cash advance, which gives you the flexibility to withdraw cash from your credit card account. Because a credit card uses the bank’s funds instead of your own, you will be charged interest on the money you spend – unless you pay off the entire debt within the interest-free period. If you pay the minimum monthly repayment, you will be charged interest. There are many different credit card options on the market, all offering different interest rates and reward options.