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Credit Crunch, Anyone?

May 5, 2012

Credit Crunch, Anyone ?

by Edmund Lao

(This appeared in the March-April 2012 issue of Money Sense)

In early history, traders used items and materials as payment to exchange products and services to each other. This process is called barter, where precious metals like gold which is abundant from one country is traded for items such as silk from another country. Each one exchanges items that the other one needs. In time, money was introduced to represent the items to ease the burden of bringing bulky items for exchange. Money became the medium of exchange worldwide up to the present. Sometime in the late twentieth century, a new form of payment was invented. This new system of payment changed the way people spend their money. The world has entered the electronic money in the form of credit card. Credit card is an ingenious and useful tool ever invented by man to improve the quality of our lives.. Just like the real money, credit card is neutral. One can either be its master or its slave depending on how he uses it. Credit card, if used wisely, can be a lot of benefit. With a credit card: • you can charge purchases and just pay for them later when you receive the bill. • you are given a high credit limit, thus you may charge purchases even if you don’t have the money in the bank right now. However, it can be a source of financial stress and burden to an individual. One will have to pay for interest and late payment charges if he doesn’t pay his credit card bill in full and on time. Knowing how a credit card works will put one to take advantage of leverage (using other people’s money). To illustrate, a friend once used his credit card to purchase cell phone to sell in six installments. Knowing the cut-off date of the credit card, he was able to collect the payment with profit even before the payment due date arrived. At the same time, he was able to accumulate points that earned him rewards such as gift cheques and items and annual fee waiver. He was able to make money work for him. On the other hand, credit card debt is death to those who abuse it. In this case, money works against the card holder. Years ago, a friend became a classic example. He used his card at the request of a relative to purchase an item. The said relative was not able to pay back the amount charged on due date. The credit card balance grew until it was already three times. My friend has no choice but to pay while his relative paid him back the original amount on installment basis. Majority of the card holder assume that the credit card is an extension of their wallet. They tend to spend tomorrow’s money today by simply charging their purchases to the bank. Most of the time, the credit limit is maxed out. They did not realize that credit card use is for the elimination of risk of bringing too much money .In short, the use of credit card is for convenience. The wrong use of credit card will plunge an individual deep in debt. Let us study how a credit card can work against us by knowing the three important credit card terms and conditions: 1.Payment due date – Payment should be made on or before due date. Otherwise, a late payment fee and a finance charge of 7.5% of the amount or three hundred Pesos whichever is higher. 2.Minimum Payment – The minimum amount to be paid is five percent of the monthly bill.. This is the amount to be paid to avoid late payment fee. However this is composed of the past due amount, a percentage of the total statement balance inclusive of all fees and any amount in excess of the credit limit. 3.Finance charge – This is the fee for the unpaid outstanding balance and the current total statement balance. By not paying the full amount, the cardholder will be considered a revolver and thus will be charged. Unpaid finance charge will form part of the outstanding balance and will be charged finance charge. This is a classic example of compounding finance charge. In general, finance charge is rated at 3.5 percent per month. That translates to a whooping forty two percent a year! Just recently, another friend missed out the payment of credit card for the first time by just one day. The total fees charged amounted to six hundred thirty sis Pesos. Others are minor fees like Cash Advance Service fee, over the credit fee, Retrieval fee, Card replacement fee, Foreign Currency Conversion fee , etc. Here is an example to illustrate: Assumptions: P100,000 debt (and no additional charge) Interest: 3.5 percent monthly or 42 percent annually Minimum monthly payment: five percent Results: If you are 20 years old at the time you swiped the P100,000 credit card debt, you will still have debt when you retire by age 65. The interest that you would pay by age 65 is more than double your original credit card debt at P233,266.72 and even after paying all that interest, your principal payment has only reached P99,971.45. Hopefully, you will bump your head and pay your entire balance when it reaches P1,000. That will still take you 25 years to fully retire your debt. Isn’t it easy to see how money can work for the bank and against the cardholder and for the bank? The problem associated with credit card fees lies not in the product but in our mindset and behavior. Below are some suggestions to help prevent or minimize credit card problems: 1.Pay in full. Before using the credit card, make sure that there is cash available for payment. Remember that credit card use is only for convenience. Paying in minimum amount will incur charges and prolong the payment term. If one does not have the money to pay for the item, he must discipline himself to wait and save up for the item. 2.Automate the utility bills. Enroll the credit card to pay for needs like utility bills and insurances. Just leave the card at home so that there will be no extra expenses. That is what I do up to now with my card. The other one is for my corporate expenses. That way, I control my expenses and I earn reward points . 3.Cut the credit card. If one can not control his emotion in using his credit card, it is better to cut it in half. He can only buy what he needs by using cash. Another idea is to save up for that item before buying. Who knows, by the time he has the fund ready, the price might have gone down or maybe he does not need the item anymore. There is nothing to lose by suppressing the feeling of instant gratification, Another option is not to avail of credit cards even if the offer is tempting. Happy Charging!


From → Loan, spending

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