With sources of credit thin on the ground and people feeling the pinch from the budget, many of us may start turning to our plastic friends to tide us through. Used correctly, credit cards are a great way of beating the system, giving you access to short-term credit at no charge, but they can very easily get out of hand. A 42in television this week can become a millstone around your neck for years to come if you are not careful.
We Irish have been very sensible with our credit cards for the past two years. When the recession bit, credit-card spending in Ireland fell immediately and sharply – there was a 10% reduction year on year between 2008 and 2009 and since then any increases in spending have been relatively slight. We also started making an effort to pay down our credit-card debt, with total repayments now regularly exceeding new spending.
However, we have not been cutting our cards up – at the end of 2008, there were 2.15 million personal cards in circulation, and that figure stood at 2.1 million in December 2010. We have kept our access to credit. This is wise, to be fair, in an environment when lenders are being particularly tight with credit. However, there is the danger that when the going gets tough, the temptation to use the credit card for everyday purchases can be very strong. The fear is that people will start using them to cover expenses as their financial situation spirals out of control, according to Michael Culloty, spokesman for the Money Advice and Budgeting Service.
"Some people use credit cards to stave off the evil day, particularly when they have a large credit allocation. There are two dangers here: one is that people will use their credit card to pay off the mortgage for as long as they can when really their income says they shouldn't be doing that. The second is that they will face heavy pressure from credit-card companies and will then give the credit card priority over the mortgage repayment. That is very worrying," he said.
Credit cards are secondary debts – they are unsecured and are not as important as maintaining your mortgage, light and heat or food – but with companies calling you repeatedly to secure payment, it can be easy to succumb to the pressure. There are some protections in place but Culloty believes some companies are going so far they may be breaking the law.
There is also a danger that someone who has racked up a significant balance on their credit card will be forced to start sticking to the minimum payment – this will give you short-term breathing room but will cost you thousands. Frank Conway, director with moneycoach.ie, said that some of the lingering debts left over from the good times are beginning to sting now.
"There's a tsunami effect, where the tide went out suddenly for a lot of people. Four or five years ago we were all being promised that wages would continue going up and the economy would keep going and we based our lives on that expectation. People were accessing a range of credit cards and it is not unusual now to find people with balances of €10,000 or more. With minimum payments, you are paying interest on interest and because it is revolving credit it becomes very difficult to pay off. I have seen cases where the required minimum payment is less than the interest charged in a month, which doesn't make sense," he said.
Take the example of someone who amasses a €2,000 balance on the credit card with an 18% interest rate and a 2.5% minimum payment plan. Paying off that balance at the minimum (assuming that you don't access the credit again) would take just over 15 years and cost an extra €2,423 in interest. That family holiday to Disneyland does not look quite as attractive when seen in those terms. However, if you exceed your minimum repayment on a regular basis, you can significantly cut down the length of time it takes to clear and the amount of interest paid. On the above example, paying back an extra €10 above the minimum monthly would shave the interest by two thirds and reduce the time spent paying it off to just four years.
"The savings on interest can be huge," said Conway. "The issue is understanding how to play around with the minimum payment. Even a small amount extra makes a difference." There's a credit card calculator on moneycoach.ie which gives you a good idea of how your repayments affect your balance.
You could also try to switch to a cheaper credit card but this is easier said than done and, in some cases, the benefit may be negligible. Competition has all but disappeared from the market. Last year, it was possible to sign up for the AIB Click card with an interest rate of just 8.5% – better, in fact, than the rate charged for most personal loans. The AIB Click card rate is still the lowest on the market but it has jumped five points to 13.5%. However, most rates now hover in the 17% to 21% region, with similarly high charges applied where cash is withdrawn. That said, there are introductory offers on the market with 0% interest charged on balance transfers for a period of time (the best at the moment is One Direct at 10 months) and similar interest-free periods for purchases (the best being Tesco Personal Finance at eight months). The other option is to consolidate your debts with a personal loan at a lower rate of interest. Either way, you need to proceed cautiously and seek expert advice, according to Kevin McNerney, director of the Financial Planning Company.
"Debt consolidation can also be expensive – especially if you opt for a loan with a much longer term which means you will be paying interest for longer. We would advise that before applying for a credit card, people take stock of their financial affairs and consider firstly if they really need this expensive form of credit and secondly, will they have control over its use and the ability to clear the balance each month."