Wednesday, December 19, 2012

All I want for Christmas...

With Christmas rapidly approaching, it has been interesting to observe the increased activity by financial institutions vying for superiority in the credit card space.

A recent report prepared by Roy Morgan Research on behalf of the Australian Retailers Association predicts that in Australia, retail spending for the month leading up to December 25th will be somewhere in the vicinity of $41 Billion.  That’s a lot of reasons for the banks to ensure they are well positioned to get their slice of the Christmas pie.

The current flurry of advertising is designed to lure customers into transferring balances from credit cards held with another bank (or banks as the case often is).  The benefit is that you can reduce the interest rate currently being paid on outstanding balances down to somewhere between 0% and 2% p.a. for a period of up to twelve months.  The great part is that all the interest you’re going to ‘save’ for the next year can be diverted to purchasing those gifts you really want to give, including those you wish to give yourself.  After all, it is Christmas and you have been good!

Great news that the banks are so generous right?

Now consider that the level of core credit card debt, that is, the debt that ostensibly remains outstanding at the end of each month, currently stands at approximately $38 Billion in Australia alone.  If we use a typical rate of interest charged on outstanding balances of say 18%, this puts the annual interest bill at around $6.85 Billion.

To make matters worse (or better if you have a bank logo on your shirt), total credit card debt is supposedly up around the $50 Billion mark, if we include all the ‘interest free’ amounts that are yet to move into the period when the full interest rate is charged.

The process for a balance transfer involves an application for a new card with an institution other than the one with which you have the existing card (and outstanding balance).  Obviously, the banks are not going to allow you to take funds upon which they are earning 15% - 20% p.a. and convert it to a lower rate.  Sure, it’s Christmas, but how far do you really expect that to get you?

As part of the new application, you will be asked to provide your existing card details and if your application is approved, within around three business days, a deposit will be made in to your existing account in order to clear the balance.  This is where the fun starts…

There is no additional action taken after this point, meaning your old trusted friend is cleared and waiting in anticipation for the moment it will be brought back into action so you can ‘come in and save’ at your local retailer.  For most, it takes just a matter of days for this situation to deteriorate when the whole point of the exercise was to alleviate the burden of the credit card debt.

Of course, if you have an outstanding balance on your credit card, the balance transfer option can be financially beneficial.  However, prior to applying for the new card, it makes good sense to contact the bank with which you hold the existing account and ask them to suspend or close the account.  They will allow the amount outstanding to remain in place and will simply cease allowing further transactions to be added (except for the annual card fee and interest).  Then take a pair of scissors to the card so you’re not able to use it again.

The temptation of having a cleared and available balance on the credit card is enormous.  If you think you are disciplined enough not to suspend your existing account and cut up your card, remember that your outstanding balance, along with the other $38 Billion exists because discipline doesn’t come easy to most.

If you require assistance with your discipline, or want a helping hand to structure a payment plan that will get you through the repayment of your credit card debt in a manageable way, talk to your trusted adviser – financially, it could be the best learning experience you ever have.

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