I was taken aback by a Standard Bank advertisement I saw last week. It read: "Time is money and a 25 percent reduction in monthly payments gives you more of both."
In the finer print lower down, Standard Bank said it was achieving this magnificent feat by reducing the minimum amount you have to repay on a credit card balance from 10 percent to 7.5 percent.
It is probably one of the most misleading financial services advertisements I have read recently.
By reducing the minimum amount you pay on a credit card balance, you will end up having to pay more, and Standard Bank, not you, will be the one with more money.
Here are the calculations (which I had Standard Bank work out so it could realise the error of its ways) to prove my point:
Let's say you bought something for R5 000 using your credit card on the day before your credit card statement was issued. If you repaid a minimum of 10 percent of the outstanding balance each month, it would take you 42 months to repay the amount, with a total of R728 in interest being paid (assuming a 20 percent interest rate).
If you reduced the repayment to a minimum of 7.5 percent of the outstanding balance each month, it would take you 60 months to repay the amount. You would pay a total of R1 022 in interest - that's R294 more than if you repaid 10 percent of the outstanding amount.
If you bought something for R5 000 on your credit card at the start of the credit card cycle, and you repaid it at 10 percent of the outstanding balance each month, you would pay R978 in interest. If you only paid 7.5 percent of the outstanding balance each month, you would pay R1 395 in interest - R417 more than if you had paid off the amount at the higher rate.
Craig Bond, who is in charge of the credit card division at Standard Bank, says the repayment rate was reduced as a result of customer demand. He says it improves cash flow. He also says a five percent minimum repayment is the international standard.
Anyone who uses credit cards as a source of borrowing, particularly to finance daily spending, is taking huge risks. Credit cards give you interest-free money, but only if you repay the full amount you owe before the due repayment date. If you are even one cent short after the repayment date, you will pay interest at a very high rate on everything you have bought from the purchase date.
Many people think they will only be charged interest on the unpaid portion. Wrong. You will pay interest on every transaction. And credit card interest rates tend to be very high.
Credit card debt is so easy to fall into because it is what is known as unsecured debt. This means you do not have to provide any security, such as an assurance policy. The result is you will pay higher interest rates.
Banks encourage you to get into credit card debt by asking you to repay only a fraction of the debt every month. But you pay those high interest rates on everything you bought during the previous month, plus the outstanding balance.
Incidentally, Standard Bank's credit card statements make it is extremely difficult for you to work out how much you owe in total. Bond says that a new format is being prepared which will make things a lot clearer.
Credit card golden rules
If you want or need to use a credit card, you must follow 10 golden rules:
- Rule One: Always repay the full amount due. Never make the minimum repayment;
- Rule Two: Never use the "budget" section of your credit card. This is definitely not a way of budgeting; it is a way of getting deeper into debt;
- Rule Three: Do not see a credit card as a status symbol, but as a potential symbol of debt;
- Rule Four: Never have more than one credit card. Every card has its credit limits which you will be tempted to use;
- Rule Five: Remember that the interest rates on credit card balances are exceptionally high;
- Rule Six: Never impulse shop with a credit card. Credit cards encourage impulse shopping, but this will have a very negative effect on maintaining your budget;
- Rule Seven: Only use your credit card to pay for things for which you have budgeted;
- Rule Eight: Never use a credit card for a cash advance unless you keep your credit card account in credit. You will pay interest from the moment you borrow money on your credit card. This also applies to buying petrol on your credit card - it is counted as a cash withdrawal;
- Rule Nine: If you already have credit card debt, consider paying it off with money you can borrow elsewhere at a lower rate; and then pay off that debt, too; and
- Rule 10: Destroy your credit card if you cannot restrain yourself from using it. If you need a credit card for convenience or security, you can ask your bank to reduce the credit part of your credit card to zero or a low amount, such as R1 000, forcing you to keep your card in a credit balance. In other words, it becomes a real credit card, not a debt card.