Personal credit cards provide a convenient and widely accepted way to pay for general and household expenses. Some of their features, however, may lead you into debt, particularly when your income is reduced and you are adjusting to changed financial circumstances.
Many people may think of getting a second credit card when they are struggling to make payments on the first. This is a serious debt trap. If you use one card to make payments on another or to keep making purchases beyond your means, your debt will spiral out of control.
You should contact your bank or financial institution to ask for assistance with managing your credit card debt. Available options include requesting a lower credit limit or cancelling the card. Ultimately, though, you need to take control of your spending and avoid using your credit card to buy goods and services that you simply cannot afford.
Please note the information on this page applies only to credit cards for personal expenses, not business or investment.
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When you can’t pay your minimum monthly payment
Credit cards allow you to spend money you don’t necessarily have, and in this way are very dangerous for people with limited income.
Credit card interest is usually the highest rate of interest for any type of loan. The only way to avoid the high interest is to stop using your credit card for cash advances and to pay the whole balance within the interest-free period.
If you have a credit card and only pay the minimum monthly payment you’ll end up in debt. More information about how, by paying the minimum payment only, $1000 on your credit card can become an 11 year loan, even with no extra purchases.
If you don’t make the minimum monthly repayment off your credit card, you’ll have to pay extra charges and interest on top of your credit card balance. This will be so even if you don’t use the card for new purchases. A late payment fee may also be added for payments after the due date.
A credit card calculator can help you check how long it will take you to pay off credit card debt under a number of scenarios.
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Flexible payment arrangements for credit cards
As with all credit for personal or household purposes covered under the Consumer Credit Code and the Code of Banking Practice, your bank or financial institution is required to consider requests for flexible payment arrangements if you are experiencing financial hardship.
If you can’t afford the minimum monthly payment, or you simply want to tackle your overall credit card debt, you need to contact the hardship department, explain that you’re experiencing financial hardship, and ask if they will vary the terms of your credit card contract. Your lender will usually require that the credit card is cancelled before they will consider this.
Because of the complex nature of credit card debt and the high levels of interest and charges, you should seek help when managing your credit card debt becomes an ongoing problem.
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Understand your rights and options
Your bank may cancel your access to additional credit immediately if they learn about your changed circumstances. Therefore, you need to be prepared to stop using your card if you request hardship variation. You’ll still have to pay off your debt even if your lender cancels your card.
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If your credit card provider is threatening or has commenced court proceedings against you, you should seek legal advice urgently. Consumer Action Law Centre provides specialist legal advice on credit and debt matters.
Keep a record of all details of your contact with your lender, including the date and time of any calls, and the name of the person you spoke to.
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How to avoid credit card debt
In a time of financial hardship you need to act quickly to bring your credit card spending under control and avoid extra interest and charges. You can do this if you:
- make your purchases using cash if possible. Avoid using your credit card unless you can pay off the balance in the interest-free period.
- if you can, pay the whole balance on the card within the interest-free period to avoid high interest charges. Purchases with your card will end up costing a lot more if you don’t keep up with your payments.
- don’t exceed the limit unless you expect to be able to pay it off in the short-term. When your income is reduced, there’s also the risk you’ll exceed your credit card limit if you continue using your card. Your lender may simply charge a higher rate of interest if you exceed your limit rather than disallowing these transactions, making your purchases considerably more expensive.
- don’t get a second credit card believing that will solve your problems. Unless you can definitely pay the card off in the short-term, another card will make your debt problem worse rather than fixing it.
- avoid using your credit card for cash advances, as interest charges apply immediately.
- consider cancelling any direct debits you have to get more control over what you pay and when. Make sure though you are not breaching contractual obligations.
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The cost of credit card debt
If you only pay the minimum monthly payment off your credit card balance, you may be reducing your debt by much less than you think.
The following examples are based on a scenario that includes:
- you have a typical credit card; and
- you don’t use the card for new purchases; and
- minimum payment is set at the lesser of 2.5% or $10; and
- interest will be charged from the date of purchase (unless you pay it off each month); and
- interest will be charged at approximately 16% per year.
How $1,000 turns into an 11 year loan
Suppose you spend $1,000, and make minimum repayments. You now have a debt on which you must pay interest. Of your first 2.5% minimum payment,
- about $13 pays interest and
- just $12 comes off the debt.
By just paying the minimum balance, you will take more than 11 years to pay off that $1,000 debt. In that time, you will pay about $860 in interest.
How $10,000 turns into a 27-year loan
Imagine now that you spend $10,000, and make only minimum repayments. As the debt gets bigger, minimum payments do an even worse job of getting rid of your debt. Of your first 2.5% minimum payment,
- about $133 dollars pays interest
- just $115 comes off the debt.
Minimum repayments now take more than 27 years to pay off your debt, costing you about $11,000 in interest.
Source: ASIC Fido website
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Case study
Stephen was an IT professional who was retrenched at the age of 55 after working with the same company for 25 years. His wife, Marcie, had left her job in administration at a hospital four years earlier following an illness that still affected her. Stephen and Marcia’s three children all still lived at home. The eldest was at university, the middle one was working in retail at a music store, and the youngest was in Year 11 at secondary school.
Read the entire case study