By Susanna Stuart
Four golden rules for reducing the cost of credit.
In 1979 New Zealand consumers entered a new era in which our traditional values of thrift and caution were cast aside. The arrival of credit cards effectively deregulated the individual shopper, allowing us to buy things even if we had no actual money in the bank. Credit cards shifted us out of the highly regulated economy in which we had to go cap in hand – some readers may recall – and apply to the Reserve Bank if we wished to take more than $200 with us on an overseas trip. If the consumer spending mindset was like a piggy bank, then by the 1980s it was now full of holes.
First came the credit cards. Then the banks loosened up the lending criteria so that we could make major purchases, or buy our holidays by simply topping up our mortgages.
Since the 1980s another layer in the financial sector has also become well-established in the market. You see these players on TV – telling us that if you can’t get a loan elsewhere, you can still get instant finance right here, right now, to buy the things you need.
Meanwhile the retail chains, many of whom make a significant slice of their income through their consumer finance arms, actively promote hire purchase. Walk into a home appliance centre and you could probably buy a big $4,000 plasma screen TV with minimal deposit and 24 months to pay. And pay and pay.
Today in 2005 we are collectively a nation of spendthrifts; one step behind our credit cards and keeping our heads just above the mortgage waterline. If interest rates were to rise significantly there would be a lot of New Zealanders in serious financial trouble.
This is the warning being made by the government and by the Reserve Bank. In a speech on October 14th 2005, our Reserve Bank Governor Alan Bollard said New Zealand households have the worst savings record in the OECD and, collectively, spend 12% more than they earn. Ouch. How did we get this way? How do we get out of this mess?
As a financial adviser I often meet people who have over-extended themselves with too much credit. On the TV show Money Doctor, I was one of the advisers who – in a move that became a signature moment on the programme – took a pair of scissors to the patient’s credit cards. “It’s for your own good,” I’d say. It was like telling a smoker to quit.
Golden rule one. Restrain yourself. Re-train yourself.
The first golden rule about credit is that it is a personal decision. Nobody forces us to use our credit cards, pay the minimum payments, top up our mortgages or buy things for which we have no hard cash. This is a personal choice, and usually comes down to our human conflict between wanting things now versus knowing that perhaps we ought to wait.
It’s time to rediscover the wonderful sense of anticipation that comes when you save up for the things you really, truly, want and need. The issue is about individual self-control at the point of purchase.
There are other ways we can reduce our exposure to the cost of credit.
Golden rule two. Pay it back quickly.
Take a credit card debt of $2,000. Imagine you decided to pay off $50 per month – just a little over the minimum monthly payment. If the card is bank is charging 19% on the credit then the debt will take five years and four months to pay off – and on top of the $2,000 you owe, you will also have paid an additional $1,148 in interest.
You can work these things out quite easily with the www.sorted.org.nz debt calculator.
The rule: pay your debts as quickly as possible. If you paid-off that $2,000 purchase straight away, (or saved up to make the purchase in the first place) then you’d have a spare $1,100 to save or spend for other things – that’s like having 50% more spare cash!
Golden rule three. Keep an emergency fund in place.
One reason people get into credit difficulties is that they’re hit by emergencies or cashflow crises. I had one once when a number of major appliances all died around the same time – the oven, the fridge, the dishwasher – I swear they were in some kind of electrical conspiracy. This is precisely the kind of moment when credit looks really attractive as a means of smoothing out the cashflow bumps. A better technique is to have an emergency fund in place, earning interest and always at the ready in case of life’s unexpected crises.
Golden rule four. Seek out the less expensive debt.
All credit is expensive, but some is more expensive still. If you must borrow, then use the least expensive credit sources, and try to avoid the expensive options. From less expensive to more expensive the list goes like this:
1. Mortgages. Secured against property, fixed rates are around 7.5% to 8% at present.
2. Revolving credit facility. Similar to an overdraft giving you the ability to draw down and repay when you want up to a predetermined limit. The interest rate is floating and slightly higher than a table mortgage but suits those with lumpy cash flow.
3. Overdrafts from your bank. These range from 11 – 17% or higher if you go over your limit. It is ideal for short-term needs where there may not be a finite term.
4. Personal loans. Less flexible than an overdraft as there is usually a fixed term. Often unsecured, interest is over 20% but is less if secured.
5. Credit cards. The most convenient form of credit giving you the first 55 days without charge. Other than an annual fee, there are no other fees so paying bills by credit card can save you bank fees. If you pay off your debt before 55 days these are a useful tool – but if you get behind they become very expensive. This option is only for those that have their spending under control.
6. Hire Purchase. Hire purchase agreements range from 16% to 30%, but there are often fishhooks, even if the terms are advertised as interest free. Other fees may be added, and the item you are buying may not be discounted – so the true cost of the purchase may be higher than you expect. Try and avoid this kind of debt.
If you find yourself in trouble with a lot of expensive debt, a good move may be to consolidate your debts into one place, preferably onto your mortgage where the debt is cheapest. You would only do this if your monthly repayment amount were lowered. If you have a serious problem with credit, seek help. Try your bank, your financial adviser, or the Citizen’s Advice Bureau.
But the best move of all is to pay off your debt as quickly as possible, and to think more carefully about the things you really, really need to buy. Our parents weren’t stupid. Try to save before you spend, and teach your children this same lost art!
The views or information given in this article are not necessarily the views of AMP or AMP Adviser Businesses. It provides general financial information and is not intended to provide financial advice. For personalised financial advice, we recommend you contact us.