Cutting out credit card debt

PERSONAL FINANCE:Overall debt levels are falling but credit card debt remains stubbornly high as we cling to our plastic but, asks Conor Pope,at what cost?

PEOPLE ARE justifiably furious at the irresponsible lending practices which have plunged the State into the worst financial crisis in its history. We rightfully blame successive governments and the banking sector for our woes, but many of us have to shoulder some responsibility when it comes to the mounting personal debt crisis which has been overshadowed by the bigger picture.

During the Celtic Tiger years, Irish banks couldn’t increase our credit card limits fast enough and unsolicited letters were sent out to consumers as many as four times a year increasing the amount of credit on offer to what we now know were unsustainable levels.

One thing the Financial Regulator got right as the boom was coming to a halt was to recognise the dangers these unsolicited preapproved credit limit increaes posed to consumers. It outlawed the practice in 2006, a move which, tellingly, was met with strong objections from both Bank of Ireland and MBNA, the two credit card providers most heavily involved in offering unsolicited credit limit increases. Both companies objected to the ban when it was first proposed in February 2005, with Bank of Ireland proving to be most reluctant to stop the practice arguing that very few customers had ever objected to the higher limits.

The party is well and truly over now and the IMF is making itself comfortable in the Central Bank, but the 2.1 million people who owe close to €3 billion in credit card debt have been left with an almighty hangover.

The collapse in the economy has meant overall debt levels have declined but credit card debt has remained stubbornly high – surprising when you consider the high interest rates attached to using the cards. According to the debt counselling service MABS, the average credit card debt owed by people who sought help last year was just over €8,000.

The good news is we are becoming a little bit more careful when it comes to our sometimes not so flexible friends. Irish consumers spent €827 million in September and paid off €846 million. It will, however, take a whole lot more than that to scale our personal debt mountain.

Of course the best way to manage your credit card is either never use it or to clear the balance each month – we know this because we all have friends and colleagues who smugly inform us that this is how they manage their plastic. And fair play to them, but for those of us who are not so fiscally responsible, the costs of managing credit cards can be controlled and reduced.

When it comes to credit card debt, the single most foolish thing a person who has run up any kind of balance can do is to just pay off the minimum monthly amount requested by the bank. Despite evidence to the contrary, those who run our banks are not stupid and they only request tiny amounts as a minimum monthly re-payment – all MBNA wants is 1 per cent of a balance, while Bank of Ireland will settle for 2.5 per cent – because asking for less makes them more, a whole lot more.

Minimum payments are never in the consumer’s interest and by paying the monthly minimum you will dramatically increase the length of time it takes to clear a debt not to mention the level of interest you will have to pay. If you owe €10,000 — not uncommon in post-boom Ireland — and pay off the minimum each month, it will take over 20 years to clear the card and cost almost €9,000 in interest repayments.

Apart from exercising self-control, the next most obvious step for tackling your credit card debt is to switch to a zero-interest option. While the days of a hyper-competitive credit card market are gone, thanks to the relatively recent disappearance of Halifax and Postbank from Ireland, there are still options on the table for the judicious switcher looking for an interest reprieve.

Both the EBS and MBNA are currently offering 0 per cent interest on balance transfers for the first 10 months. MBNA however limits this largess to its Platinum card and some of the cards which are sponsored by other companies and it charges a rate of 1.9 per cent interest on its standard and gold cards. EBS also offers a 0 per cent rate on balance transfers for 10 months while Permanent TSB and Tesco will give 0 per cent for six months.

This can really make a difference. If you were to move an outstanding balance of €10,000 from a card with an APR of 16.5 per cent to a zero interest option you save almost €850 in interest payments in the first six months alone.

Switch again at the end of the introductory period and you will quickly find yourself mining deep holes in your debt mountain. A canny consumer could switch four times over the next two-and-a-half years and not have to pay any interest on their credit card debt.

The switching deal is not without its problems however and you have to read the small print. Tesco, for example, has a 2 per cent fee on all balance transfers made during the first four months from account opening, while transfers are also restricted to 95 per cent of the credit limit.

With most cards, a failure to pay off the minimum at any point over the course of the interest-free period is considered a breach of the terms and conditions and they will take your zero rate off you faster than you can say: “the cheque is in the post.”

It is also essential to look beyond the balance transfer rate of interest and assess how much the new credit card provider will charge you for using the card after you have made the switch. Remember that all payments you make will go towards the cheaper debt first. So if you transfer a balance of €10,000 at 0 per cent and then spend another €1,000 at the card provider’s normal rate, your payments go towards the €10,000 balance first allowing the €1,000 to grow at a healthy – for the bank – rate.

If you have a small balance which can be cleared without too much difficulty it also makes sense to switch to the company offering the cheapest credit. Right now the cheapest card on the Irish market comes from AIB. Its Click card has an APR of just 9.5 per cent. It is not without its flaws and charges a 23.4 per cent interest rate on cash withdrawals, the highest rate on the market, and even charges a cash advance fee of 1.5 per cent when your account is in credit.

KEEPING YOUR CREDIT CARD IN CHECK

LEAVE IT AT HOMEHaving immediate access to a credit card facilitates impulse purchases. If you have to go home, pick up the card and then go back in that high class department store – yes, we're talking about you Brown Thomas – before you can spend more than €500 on a pair of shoes, you might give yourself time to think twice. And then decide against it.

MACHINES ARE MADNESSUnless you have absolutely no choice, never use your credit card at an ATM. Not only are you hit with charges for using the machine – AIB charges 1.5 per cent, or a minimum of €1.90, on the value of the transaction on its Platinum card. This means a €1,000 withdrawal will cost you €15, and you then have to start paying interest immediately. And if you withdraw money outside the eurozone, you will be hit with an additional currency conversion 1.75 per cent charge in Europe, and 2.75 per cent in the rest of the world.

DON'T PAY LATEIf you do you will be hit hard. MBNA charges €15.24 as a late-payment fee. Companies also make you pay interest on the full amount from the date of purchase.

BORROW TO CLEAR ITYour credit union will charge an interest rate of less than 8 per cent while your credit card charges double. It only makes sense to borrow to clear the debt if you have the willpower not to allow the credit card debt creep up again as Christmas approaches.

BRING IT DOWNIf you "benefited" from your bank's largesse during the good times and are now in possession of a credit limit that would make a financially solvent country blush, you might want to contact your bank and reduce that level to a more realistic one.

FREEZE YOUR ASSETOkay, we appreciate this may sound a little mad but we have heard of people who have done this with great success. Immerse your credit card in an ice tray full of water and freeze it. This is a great way of stopping spur-of-the-moment online spends as you have to wait until the ice melts before you can access the card. There is no point in trying to chip the card out as you'll damage it and as for trying to defrost it in the microwave, don't even think about it.