As I mentioned in one of my earlier columns, it does not make any sense to even think about saving money or investing while running unpaid credit card debts.
This sounded harsher than intended. In the end, saving helps us keep at least some control over our often painfully stretched finances – in one pot goes the school fee, in the other, money is put aside for the new bathroom, and the change in the jam jar is for the green grocer. And hopefully one of these mental jars is reserved for our credit card repayments too.
This is fine. The point I wanted to make though was not to discourage saving but to point out that credit card debts are more expensive than we can ever hope to earn with a savings account or a reasonable stock investment. As a result, we will be poorer. This is, economically speaking, irrational.
I would have forgotten about my truisms if a report had not caught my attention analysing the risks accumulated by UK banks offering “balance transfer credits” at zero per cent interest for up to 43 months. In other words, if we ever struggled to repay our outstanding credit card debts, banks like Virgin Money, Santander or Barclays now offer a helping hand with a bridge loan free of charge for more than three years.
What the regulating financial authorities started to worry about was not so much the banks’ new-found altruism but the fact that the booked zero income was a yearly profit, while earning, in fact, nothing. If this sounds like the auditing acrobatics of Enron (the failed US utility accounting infamously for future profits it never made) all over again, it is: to book a hoped-for return of the future as profits today is reckless.
But for us consumers there is an even more sinister side to it. Banks are so dead-sure of making a killing on us gullible credit card customers in the near future that they consider at least part of it as earned already.
How is this possible? What if we just jumped on this window of opportunity, paid off all our debt, free of interest, and lived happily ever after?
Credit card debts can ruin your health. It can ruin your family. It can lead to life-long servitude
The sad truth is: these banks know we won’t. They have decades of math to prove their case. Their only risk is a stalling economy, resulting in higher unemployment, or rising interest rates forcing more credit card customers into bankruptcy than they have reckoned.
In the meantime we will pay, stupid.
Credit cards operate like legal loan sharks. They earn a fee from the card holder, a transaction fee from the retailer, and they get rich from the interest we pay. This is why every shop worth its name, every airline, every club is peddling one. Get 20,000 air miles on your new credit card free, get €200 cash back on the first €1 you spend, get 15 months credit for free: the incentives are alluring and tempting and shiny like the beautifully designed cards themselves.
Why has nobody come up with the idea yet of sticking a health warning on these little wallet jewels, like the tobacco companies are forced to do? “Credit card debts can ruin your health. It can ruin your family. It can lead to life-long servitude.”
And this is how it works. As if 18 per cent interest would not be enough, banks have invented the ruse of the Minimum Payment. When the credit card statement comes in at the end of the month, we are generously offered to defer payment as long as we pay a “minimum” – typically a small percentage of the outstanding balance, or a few euros, whatever is the bigger of it. It serves as a proof to the company that we are willing to honour our obligations, but are just not ‘in the mood’ to pay it all at once, as we rather should.
Let’s assume an outstanding amount of €3,000, interest charges of 18 per cent per annum – as easily the case – and a minimum payment of one per cent. Let’s further assume that we will never rack up new debts but keep paying the minimum payments until everything is paid off (for this to happen the credit card has to be shredded, I know). To repay those €3,000, it will take incredible 27 years. At the same time we will have handed over €4,000 in interest. Provided we were never a day late with our payments and no default charges were therefore added.
The only reason this works so well for the banks is our financial illiteracy. A report in a paper showing charts and graphs as a clarifying illustration is regularly skipped by us. No math, please. It is EU law that every credit offer, like a mortgage or a credit card, has to clearly state its total cost. This is called APR – the Annual Percentage Rate of Charge, which should make price comparisons between different credit offers easier, or at least possible.
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Most of us have no clue what this ugly acronym means, and whether this “APR” is presented “nominally, typically, representatively, or according to our credit standing”, which could make a tremendous difference to our pocket, but certainly not in our mind. Who would wish to calculate the cost of a loan according to the formula:
No volunteers? Then maybe better to refrain from the temptation of minimum payments. And if you are in the red already, shamelessly make use of these 43 months “balance transfer credit at zero per cent” offers while they last, until all is repaid in full. Perhaps this time it’s we who can laugh all the way to the bank and back.
Andreas Weitzer is an independent journalist based in Malta. He reports on the economy, politics and finance. The purpose of his column is to broaden readers’ general financial knowledge and it should not be interpreted as presenting investment advice or advice on the buying and selling of financial products.
Please send in any suggestions for discussion in this column to: editor@timesofmalta.com – Subject: Sunday Times Personal Finance.