Tag Archives: credit card interest

A Self-Defeating Financial Game

 

There are a number of common self-defeating games we play on ourselves that have a real negative impact on our finances. The most common one is claiming we got ripped off. To skip ahead: We didn’t get ripped off – we paid what I call a “stupid tax.”

News flash: Whatever you got ripped off on, you purchased voluntarily and signed a bill of sale or order online. There are no sales or banking people who carry a gun – honestly. If you say to others, and more important, to yourself that you got ripped off, it makes you a victim and it’s not your fault. If you’re a victim, there’s nothing to be done, and no lesson to be learned.

Change the wording: I LET myself get ripped off. You didn’t ask enough questions, the right questions, signed up to quickly, didn’t comparison shop, were naïve, or trusted someone who lied to you. That’s on you! It’s hard to say. I know – I’ve been ripped off…I mean…let myself get ripped off. And when I change the wording, I change my thinking and change my behaviors so it doesn’t happen again!

It’s always nice to learn from the mistakes of others. But few people choose to do that. We somehow, for some reason, don’t take in those lessons and need to get burned ourselves.

A relative called me yesterday and he was furious. He had a Visa balance last month of $1107. His next trip to the bank machine, he transferred $1100 to pay off the balance, thinking he was done. Yesterday, his statement arrived and charged him over $21 of interest. Yes, it’s true. If you do not pay the FULL balance, you’ll be charged interest for the last month on the entire balance. In other words, his rounding down didn’t just charge him 20% on the seven bucks – it charged him on the full $1107.

If in doubt, if you don’t remember the exact amount when you’re at the ATM, round it up! I call this a stupid fee. He was charged $21 for a good lesson – and, in his case, you can bet it won’t happen again!

Do You Have a 50% Credit Card Rate?

If that sounds insane, it really isn’t. Millions of Canadians have it – they just don’t know it!

Numerous surveys over the past few years show that one quarter of Canadians are cashing in some of their RRSPs before retirement. That’s more than 1.8 million people. Say it ain’t so as the old expression goes.

Two of the most common reasons for you to consider cashing in all or part of a retirement plan are to purchase a home or to pay off debts. Let’s assume you want to cash in $5,000 to pay off a credit card. The first thing you pay is a 10% penalty right off the top. So you’re actually getting $4,500. Then this amount is taxed, as if you made that money as income. In a 30% tax bracket, that’s another $1,350. So the bottom line is that the $5,000 you cashed in is really only $3,150 of net money going on your credit card. Sure, it’ll save you 20% interest on the card, but that’s not the whole story.

That money is no longer growing in your RRSP (or your Tax Free Savings Account). At a 10% return, that $5,000 would have doubled every seven years. If you’re in your 30s, you’re now missing around $160,000 at retirement. If you’re in your 50s, that $5,000 still would have doubled three more times, which is $40,000 now gone.

While you’ve now been able to pay just over $3,000 on your credit card, it likely didn’t pay off the balance. That’s bad enough with what it’s cost you in foregone investment income. Now to make things worse, the majority of people keep using that credit card again! Odds are, you’re in the majority where you’ll be back to an average $7,000 balance within two years.

That puts you back to paying 20% on your card while you’re out at least $40,000 in savings for the next 20 years. The bottom line: Your credit card is then costing you more than 48% interest. While you were hoping to make things better – they got worse – a lot worse.

On the plus side, how would you like a zero risk 28% return on your money? It’s easy: Just pay off your credit card. The 20% interest rate you pay is with after-tax money. So the real rate is over 28% if you carry a balance. That’s the biggest reason trying to save at the same time you’re trying to become debt free doesn’t work!

A Common Financial Trap We Do to Ourselves

At least three times in the past few weeks I’ve heard a common financial strategy from people with a bunch of debt: I’m going to transfer it from my credit card to my line of credit because the rate is so much less.

Yes, but no: If you believe that the interest rate matters a lot, and that your debt is about math, you’re sort of right. Sure, transferring something from 20% to 6% might be a good idea. But getting into debt, and out of it is, not about math. It’s almost all about psychology. If it were about math we wouldn’t use a 20% credit card, or buy a new vehicle that has dropped $3,000 to $5,000 in value before we get it home!

Remember that transferring your debt around is NOT the same as paying it off. All you’re doing is shuffling it from one place to another, none of which accomplishes a thing in the total amount you owe.

If you owe the money on your credit card, you’ll be way more motivated to pay it off, exactly because of the high rate. If it’s transferred to a line of credit, that motivation goes down the drain. If you do it – fine. But in two years, look back on the math and add up what you’ve paid in total. I’d bet, for most people, it’ll actually cost more since we stretch out the repayment forever.

When we transfer this $1,000 or so, it also pays down our credit card. Hurray – now we have another excuse to use our credit card again because the balance is gone. We tell ourselves the balance is paid off, but forget that it’s just owing in a different place. But six months down the road, the credit card is run up again and we STILL owe the transfer on the line of credit. That makes things worse – way worse than leaving it on the credit card and focusing on paying it off.

I’m not even dealing with the fact that we still think debt is our friend and haven’t wanted to separate our wants from our needs. That has to be true, or we wouldn’t have charged this amount, but saved the money first. Then we can buy whatever it is and actually afford it!

It’s a vicious cycle that credit card companies and our line of credit lender love to assist us with, and keep us in forever. And we’re more than willing to play the game. But it comes at a very high cost in a number of ways.

Break the cycle. Buy it when you can afford it. And if you ignore that advice, which you will, leave it where it’s owing, and get on with paying it off as quickly as possible. That will be quicker, less costly, less likely to run up the credit card again, and less stressful.