In Australia, there are more than 16.5 million credit cards, creating a national debt of more than $32 billion!* Pretty amazing figures, aren’t they?
It’s easy to see why so many of us are lured in by the ‘fantastic plastic’ – they’re so convenient and you can earn loyalty rewards. There is a downside though, with interest and annual fees to be paid, and the potential to get yourself into debt if you don’t manage your payments.
To help you work out if a credit card is right for you, and to learn more about how they work, take a look at this list of things to consider:
Let’s start with a definition
Essentially, a credit card allows you to borrow money from your bank or other finance provider to make purchases. You then need to repay the amount you spend on the credit card, within a specified timeframe, or you will incur interest on top of what you have borrowed.
With most credit cards, you’re able to nominate your preferred credit limit, or the financial institution will apply a maximum credit limit available to you based on the information you provide in your application. While it can be tempting to nominate a high credit limit, this can easily lead to over-spending, so be careful. You can usually increase your limit in the future if you find that you need it.
How interest works
Depending on the card that you apply for, interest rates can range from 8% up to 26%, with the average being around 17%. This is essentially the fee you pay to the bank on top of purchases for the privilege of borrowing their money. With most cards you are charged interest on all outstanding transactions if you don’t pay your full balance each month. The full balance is your credit card balance as at your account statement closing date, which is the date your billing cycle ended and your credit card statement was generated. It is important to know when your account closing date is so that you can plan large purchases around which month you want the cost to fall into.
Some cards come with interest-free periods, which offer a number of days (often 55) during which you don’t pay interest on your purchases.
You will usually receive a monthly statement outlining the credit card’s closing balance. You can then choose to repay either the full outstanding amount or the minimum monthly payment shown on your statement by the due date. If you don’t pay off your full balance, you will incur interest charges. A good way to prevent interest charges from being incurred is to set up a direct debit to automatically pay the full closing balance each month before the due date.
Credit cards with a rewards program give you points for every dollar you spend on your card, which you can then redeem for certain goods or airline flights. However, these types of cards tend to have higher interest rates and fees, and can sometimes end up costing you more than the reward is worth. To learn more about rewards programs, take a look at the MoneySmart website.
With the above information in mind, you’ll be in a much better position to manage your card, and most importantly save unnecessary fees and interest that could go into building up your super.