
Credit card debt will suffocate you unless you take deliberate and measured steps now to extricate yourself from it.
From time to time, we hear reports about the level of credit card debt being carried by Barbadians. The 2018 Financial Stability Report, a collaborative publication by the Central Bank of Barbados and the Financial Services Commission (FSC), put Barbados credit card debt at 347 million.
The same report noted that the number of credit cards in Barbados had increased by more than 40 percent between 2015 and 2017; from just under 91,000 to almost 129,000.
The Enticement
An increasing number of persons are being enticed by their bank to take a credit card from their wholly owned credit card company. Many Barbadians have more than one credit card because collectively, credit card companies are allowing Barbadians to have multiple credit cards. There is a very “good” and sinister reason for this. Please read on.
The Deception
While you may feel comfortable, even “smart” paying bills with a credit card each month, the first reality check you now need to take is that paying with a credit card facility is just not the same as paying cash. A credit card facility is another form of debt.
That truism is worth repeating: a credit card facility is just another form of debt!
A second truism worth noting is that, like any other form of debt, credit card debt attracts monthly interest. You are not just paying back what you “borrowed” by paying with the card.
The credit card arm of one local bank says its interest rate 1.03 percent. That sounds like a very low rate but if you annualize it, that is, compute it over a full year, it becomes 12.36 percent (1.03 x 12 months)!
Annualizing the interest rate is not unique to credit card companies. Retail outlets report their hire purchase rates in the same manner: a monthly rate and a yearly rate. Check any hire purchase agreement old or new and read the fine print. The trick is in the presentation!
The third truism about credit card debt is that it employs compound intertest. What that means is that the amount of interest is not fixed but is computed on the amount borrowed but not yet paid back.
For example, if the bank agreed to lend you 50,000 towards a mortgage, that sum is called the principal. For illustrative purposes only, if you paid back 10,000 before the end of the first month of the mortgage the principal would now be $40,000. That is the sum on which you would now pay interest.
From this perspective, credit card debt is similar to a mortgage. You are charged interest on the amount of debt remaining at the end of each month.
However, what causes people to fall into a credit card debt trap is that, unlike a mortgage, there is no fixed payment made on a credit card! Think about that for a moment.
You already know this if you have a credit card but did you know that is one of the big deceptions which causes people to fall further and further into a credit card debt? Is that what it is doing to you?
Mortgage payments
One way to understand this deception is to compare credit card payments with mortgage payments.
A mortgage type agreement always stipulates the amount you will repay each month. Therefore, you know when you will finish repaying the mortgage. That holds unless the bank increases the mortgage interest rate.
So, let’s see how a typical mortgage payment works. To keep matters simple, we will use a mortgage of $5,000 rather than $50,000 to avoid confusion from grappling with too many figures. Let us also assume that the agreement is to pay back $800 per month and that the monthly interest rate is 1.5 percent.
At the end of the first month, the bank computes interest on the principal. It means that your interest for the first month is $75 (5,000 x 1.5%).
That interest must be paid first; that is a basic principle of banking. So the bank takes out $75 out of the $800 payment and the rest goes to reduce the sum borrowed. In other words, NOT all of your $800 is applied to reducing the sum borrowed!
In fact, at the end of the first month, only $725 goes to pay off the principal. So at the beginning of the second month, you now owe the bank (5,000 – 725) or $4,275.
Another way of looking at, it in total, is that at the end of the first month, the total you owe the bank is $5075 (=5000 + $75). So your first $800 payment is subtracted from that amount leaving you owing the bank $4,275 for the next month, same result as above.
This calculation can be shown more conveniently on one line as follows:
How long would it take to repay the bank given that the interest rate and the monthly payments are the same? As you can see from the repeated calculations below it would take 8 months.
Notice that the last payment is less than the normal monthly payment. This is true of all mortgage type payments such as your hire-purchase accounts. This has to do with the nature of these calculations.
Credit Card Example
Now let’s see how this works with a credit card account. We will assume the same facts as with the mortgage: that is, the amount “borrowed” initially ($5,000) and interest rate (1.5%). However, there is no fixed monthly payment! Here is what would happen if you paid $500 per month.
As you can see, it would take 12 months or 4 months more than the corresponding mortgage to reduce your credit card balance to zero!
I leave you to guess how long it would take if you paid something like $300 which is probably the minimum the credit card company will ask you to pay every month!
The Tricky Minimum
In most cases, credit card companies make more per dollar of loan out of credit card debt that mortgages! That is one of the main reasons why all the commercial banks started credit card companies!
Credit card companies do not wish you to get your balance to zero. The monthly minimum payment they charge will NEVER reduce your balance to zero anytime soon; that is by design!
Minimum payments are a credit card debt trap! By now, you can see that the credit card company will make more money out of you with this minimum payment than if they forced you to make a larger pre-determined payment that will close your debt at a specific time.
They will never tell you how much to pay to close the debt; it is up to you to figure that out and implement it. In other words, you have to treat credit card debt as though it were a mortgage with a fixed monthly payment so you can get out of it. From the calculations shown you know this is possible. It just takes some will power.
Overdrawn Fees
But there is another “trick” the credit card companies have up their sleeve. Unlike a mortgage which has a principal that is fixed, credit card companies have what is called a limit. If you ever go over the limit, there a whopping overdrawn fee you must pay in addition to interest and other charges!
This occurs if your credit card balance is near the limit. When the company does its monthly or cyclical calculation of interest, the interest is automatically charged to the balance rather than added to the payment you have to make!
So for example, if your credit card balance is say $ 110 and the interest works out to be $115, your credit card account will then be throw into an overdrawn situation of $5 for which you may them be charged, say $75 in overdrawn fees. Your account will then show a total amount overdrawn of $80 for which you will be charged overdrawn interest EACH and EVERY DAY.
Do Not Bite
Common sense would suggest that you NEVER agree to have your credit card debt limit increased. Don’t think for one moment that the credit card company is being nice to you; they know that as long you pay that minimum only, you will quickly get past that limit.
The companies are constantly studying their credit card debt to see who else they might entice and devour with a “generous” limit increase! Don’t take the bait!
Call to Action
We have taken the time to write this article because we know that many Barbadians are deep in credit card debt. We know that credit cards are important in making overseas payments, for example for software downloads, tuition fees etc.
You may have come into a high level of credit card debt because of big payments made over time for legitimate reasons. But now is the time to get out! Treat the current figure as the principal and start from there to liberate yourself.
If you are drawing close to retirement it is time to get out of credit card debt. Indeed, the first thing you should plan to do with your lump sum pension is pay off that debt if you have not done so before! You will feel much better after you return from that cruise to celebrate your release from the daily rat race!
This does not necessarily mean that you are closing your credit card account; it simply means you are NOT playing by the rules of the loan shark. When you make a credit card payment, pay it off immediately or before the end of the month or cycle. If there is no balance there can be no interest!
Finally, remember the advice of scripture:
“The borrower is servant to the lender” Proverbs 22:7b
Do let us know if this article was helpful.
UPCOMING
Dumping Credit Card Debt: Step by Step Guide