When credit card debt really scares you

Last year Australians put $24.4 billion on their credit cards. Sally Patten and Larissa Ham look at how easily credit card debt can spiral out of control.

Jo Pugh’s spiral into credit card debt began when she was a 20-year-old student. Only earning about $200 a week, and on a youth allowance, a bank approved her for a credit card with a $7000 limit.

“I guess I wanted to have the freedom to be able to spend a little bit more freely just for the sake of being social,” says Pugh, now 27.

“I maxed [my limit] out really quickly and ended up in this pattern of paying the minimum repayment every month and then feeling like that money was mine,” she says.

Aiming to clear the debt, she applied for another credit card with an interest-free balance transfer, and then another.

Finally, she took out a $7000 personal loan – and despite the fact she says she wasn’t living particularly extravagantly, her total debts had mounted to around $20,000.

Big numbers

Credit cards are one of those areas where the figures can be mind-boggling. Telephone numbers, even of the mobile variety, do not even begin to tell the story.

Last year Australians whacked $24.4 billion in purchases on their credit cards, up from $21.9 billion the year before, according to comparison site finder.com. By December 2015, total outstanding balances on credit cards stood at $51 billion, with nearly two-thirds of it, or $32 billion, accruing interest. It also found that the average credit card balance at the end of 2015 was just over $3000. This suggests that cardholders are paying hundreds of dollars in interest a year.

Source: ASIC’s MoneySmart website, November 4, 2016. Reproduced with permission of ASIC.

A lot of people pay off their bill each month and never pay interest charges, but sadly many do not and subject themselves to high rates of interest. Unless they have a low-rate card, rates can be anywhere between 15 per cent and 20 per cent.

Indeed, in some horrendous cases, mounting credit card debts end in bankruptcy. This Fairfax article from March tells the story of a Melbourne couple in their early 40s whose failure to pay an $18,000 credit card debt ended in eviction from the family home.

Strategies for paying down the debt

Adele Martin of Firefly Wealth warns her clients to rein in their spending as soon as they stop paying off their credit card balance in full each month. “As soon as you can’t repay your bill each month, you are living beyond your means,” she says.

For clients who have already accumulated debt on their plastic, Martin recommends using her two-step plan:

  • First, she gets clients to build up a cash buffer of at least $1000. This will be used for emergencies so that clients who are trying to pay off their debts don’t start adding to them when they get hit with an unexpected repair bill.

    “The buffer, or emergency fund, is so that people don’t start to build up their debt again. This can easily happen if there is nothing to fall back on and it can become a vicious cycle. Psychologically it gets too difficult and people feel like giving up,” Martin says.
  • For those who can, the second step involves transferring the balance to an interest-free card and making a plan to pay off the debt within the interest-free timeframe – usually between 12 and 18 months

The repayment plan inevitably involves taking a knife to a client's expenses, but the Firefly adviser says it is usually not such a difficult task. Indeed she can usually find about $3000 of annual savings in clients’ budgets by looking at items ranging from mobile telephone bills and cable television to gym memberships. Martin recommends that gym memberships that are not being used are cancelled. Martin suggests clients also hunt around for better deals on energy bills and mobile-phone plans, particularly if they are breaching monthly caps for calls and the like.

Don’t let it snowball

For clients with more serious credit-card balances, more drastic action may be needed. For example, in some cases, a client might have to look at moving in with their parents or getting a housemate. In addition, they may need to look at their earnings. It might be time to look at their finances to find a way of earning additional income.

Credit-card debt – and the stress that can come with it – can snowball if not kept in check, as that family from Melbourne discovered.

After a trip overseas last year, Pugh knew things had to change, and she cut up her cards. “I don’t know why it took me so long to do that.”

Back at university, and working as a waitress, Pugh has halved her debt in a little more than a year, and hopes to be in the black within two years.

“As soon as I get paid, I’m putting money on all of them rather than waiting until due dates,” she says.

She hasn’t made any significant lifestyle changes, apart from working more.

“I still feel pretty overwhelmed, particularly when I think about the amount of money that has essentially been blown on interest.”

November 2016