Five steps to slash credit card debt
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You've spent up a storm on the credit card and now your internet shopping binge is racking up interest at a frightening rate.
Don't panic. There is an easy way to avert disaster and get your head above water.
Best of all, if you follow these five steps, you get to give your bank a good spanking along the way.
STEP ONE: ASSESS THE DAMAGE
As at May this year, we New Zealanders had amassed a collective $6.15 billion worth of credit card debt.
The first step is working out your own personal contribution to that gaping whirlpool of red ink.
If you have got more than one card, add up all the balances, and check out the interest rates.
According to the Reserve Bank, the average interest rate people are paying is 17.3 per cent.
Recent estimates put the average credit card bill around $3600, so we will use that as our template.
With a minimum repayment rate of 3 per cent a month, it would take a staggering 14 years to repay.
Over that time, you would also end up paying close to $3000 in interest, almost doubling the original debt.
Use this calculator to work how long your own debt would take to clear.
This is an incredibly expensive option, and it is exactly what banks want you to do.
The minimum payment level is cynically calculated so that you are only ever chipping away at a tiny bit of the actual debt.
STEP TWO: SLASH INTEREST
Even while you are treading water, banks will fight each other to toss you a lifebuoy.
It is called a "balance transfer", and you should grab it with both hands.
You may have seen ads popping up recently offering 0 per cent interest for credit card balances transferred from another bank.
A couple of years ago, the going rate for balance transfers was 3-5 per cent. Earlier still, it was more like 8 per cent.
"There is clearly a war on out there, which benefits the consumer," says Raewyn Fox, chief executive of the Federation of Family Budgeting Services.
Specials come and go, but those who are drawing the battle lines at the time of writing were ANZ and Westpac.
Westpac spokeswoman Haley Ritchie says the bank was among the first to run balance transfer campaigns.
"Competitors have followed as they have proved popular with customers," she says.
ANZ spokesman Stefan Herrick says the deals have indeed become more popular over the past two to three years.
Both banks are offering to waive all interest for a year on transferred balances.
For our $3600 debt, that would save over $660 in interest charges.
The Bank of New Zealand has the next best offer, charging only 1 per cent interest for a year.
However, that is only for those who have their main income paid into a BNZ account.
The regular rate is 3.99 per cent, which would still save just over $500.
Kiwibank's offer of 1.99 per cent interest on the transferred balance and new purchases sounds attractive. However, it is only for six months, and so would only save you about $280.
ASB finishes in last place by definition, because it does not offer a deal and hasn't for some time.
General manager products and strategy Shaun Drylie says the bank instead aims to offer a "no strings attached" competitive interest rate on all credit cards.
"Our most recent offer of 0 per cent on purchases for five months and zero fees for life is an example of this," he says.
STEP THREE: STOP SPENDING
The 0 per cent and 1 per cent offers are clearly loss leaders. The banks are actually losing money in order to win your business.
Sounds too good to be true?
Unless you tread a careful path, there are a couple of pitfalls that will quickly tip the balance back in the bank's favour. The lenders have a few tricks up their sleeves, though they are hidden in plain sight.
"The first thing you have to do is make sure you have read the terms and conditions," says Fox.
Big mistake No 1 is to keep spending. With the exception of Kiwibank, any new purchases start racking up interest at full cost. This is a double-whammy. You might assume you can add a couple of morning lattes on top of the transferred balance, and then quickly pay them off.
In fact, they will be the most expensive coffees you ever drink.
Any repayments go towards the transferred balance first, rather than the bit that is actually racking up interest.
That means you have to clear the entire card before you can think about new spending.
To avoid temptation or confusion, leave the card safely hidden away at home, or even cut it up.
STEP FOUR: MAKE A PLAN
The second big mistake is to transfer the balance, breathe a sigh of relief and then do nothing.
Six or 12 months will fly by, and you will be right back to square one.
"What you should really do to take advantage of it is … aim to have it paid off in that period of time," says Fox. "Make monthly payments of what you owe, and get rid of it before the interest comes back on."
Setting up an automatic payment or direct debit is a good idea but that is not enough by itself.
"You need to have a really good plan to make that happen," says Fox.
Of course, some people will be so mired in debt they won't have a chance of clearing it in a year.
Wellington financial adviser Alan Borthwick, of Dux Financial, has had clients transfer as much as $18,500 in one go when consolidating several debts.
Although there is "no way" they can ditch the lot, they can certainly make a big dent, he says.
It also provides breathing room to tackle other problems, which may be more pressing.
"If they're not able to roll everything in, it will free up money to hammer some of the smaller [debts]," says Borthwick.
STEP FIVE: CREDIT SURF
If you do need more time, not to worry. Simply go back to step two, rinse, and repeat.
Yes, that's right. It is entirely possible to hop from bank to bank as each offer comes to an end.
If you still have your original credit card open, you can take turns exchanging the balance between them, or to a different bank entirely.
Keith McLaughlin, managing director of credit reporting bureau Centrix, says banks can see your credit card limits, the number of cards, and how far behind on payments you are.
"If you have multiple cards you are a higher risk. When a credit card issuer is looking at you, they would take that into account," he says.
But assuming you close off each old card as you go, there is no issues for your credit score.
"Each organisation will potentially look at it differently. They might say, if he has moved three banks … how loyal is this customer going to be for us?" McLaughlin says.
"But if you are talking about credit risk, no."
The only other risk is that the juicy offers won't be around forever.
"Funding costs for banks and credit card providers are starting to rise, which will raise questions around the sustainability of balance transfer rates at their current levels," says ANZ's Herrick.
However, they are highly unlikely to disappear overnight.
THE AIM OF THE GAME
Borthwick is always wary when recommending balance transfers, for fear they will be used poorly.
He says some people revel in the low interest and forget about the actual aim of the game, which is to become debt-free.
"That's tomorrow's problem. Today's problem is about ‘how do I enjoy the weekend'," he says.
"And that is how they get you."
As long as you keep the purpose firmly in mind and steer clear of the pitfalls, balance transfers are a great tool.
For once, you get the opportunity to rip off your bank, not the other way round.