Interest-free deals look good but they can end up costing a bomb, writes John Collett.
Christmas can be a risky time for those struggling with debt. Financial counsellors say that one of the most potentially pernicious types of debt is that carried by store cards, which have an annual interest rate of between 20 per cent and 30 per cent on missed repayments.
The cards may have rewards points, gifts and invitations to “exclusive” shopping events and free gift wrapping – all to make customers feel like VIPs.
The co-chief executive officer of the Consumer Action Law Centre, Carolyn Bond, says “it can take our focus off what the card costs”.
These cards can easily trap those who do not use them wisely, she says.
The biggest traps of all are the tantalising specials on big-ticket items offering up to five years interest-free. Consumers often enter the deals believing they will be able to come up with the cash at the end of the deal and don’t sufficiently dwell on what will happen if they don’t.
All major retailers have relationships with credit card companies or other credit providers where the credit cards are co-branded with the store. There is the traditional “store” card, where points are earned for using the card to make purchases at the store and the points can be redeemed in the store’s gift vouchers. They will also have a co-branded card that links to one of the big rewards schemes, whereby rewards points accumulate for spending on the card.
The temptation to overspend using credit is always acute in the lead-up to Christmas. And the headache for consumers does not come until well after the festive season.
The chief executive of the privately owned debt-collector Prushka, Roger Mendelson, says January to February is the hardest time to collect money.
“There is a definite pattern where people overspend before Christmas,” he says. With leave loading, most workers probably have more money in their pockets just before the festive holiday than at any other time of the year.
“But is goes very quickly and there is a huge spike in credit-card spending,” Mendelson says.
Retail spending is fragile. More people are buying goods online from overseas, spurred by the high Australian dollar and that no GST is payable on overseas purchases of less than $1000. In response to soft sales, retailers may extend the “easy” credit conditions this Christmas such as lengthening the interest-free periods. They may also extend the time before minimum repayments begin.
Interest-free periods, where there is no interest paid for a limited time on purchases, are one of the biggest potential traps for consumers, Bond says. “You see people whose credit-card problems go back several years but started with an interest-free deal,” she says.
All credit cards have the potential to get people into trouble. But it’s store cards that have the nastiest sting in the tail, with interest rates of up to 30 per cent on outstanding debt on the card when the interest-free period runs out.
Some retailers have interest-free periods of five years with no deposit required. Some have an initial period of several months where no repayments have to be made on the card at all.
While interest-free periods can be attractive, the danger is if the minimum payment is not made or full payment is not made by the time the interest-free period ends. In either instance, consumers start paying an interest rate of up of to 30 per cent a year on the outstanding debt.
The principal solicitor of the Consumer Credit Legal Centre (NSW), Katherine Lane, says the risks of having debt left on the card at the end of the interest-free period or defaulting on making the minimum monthly repayment are high.
“You can easily get into a situation where you are overcommitted,” Lane says. That’s especially so if consumers use a high-interest-rate card to make cash advances and other purchases, where the interest rate can start straight away. Most credit cards, including those with high interest rates, require monthly minimum repayments of only 2 per cent or 3 per cent of the debt. Paying just the minimum means it may not be repaid for decades.
Card providers will often give consumers a credit limit on their high-interest-rate card that is higher than that required to make the purchase. It’s important that consumers wanting to take advantage of interest-free deals insist that the credit limit on the card is no more than the amount of the purchase, Lane says.
Bond says stores may pay the credit provider for the interest-free credit. The prices on the goods with the interest-free periods could be higher than the prices of the same goods at other stores that do not offer interest-free periods.
Bond says consumers should try to negotiate a lower price with the retailer by offering to pay with cash or a low-interest rate card and forgo the interest-free period, or find the same product for a lower price at another store. A spokesman for Choice, Christopher Zinn, says some people can do well out of these sorts of deals, “those that are savvy and engaged and do things on time, it can work for them”. But there are a number of hurdles, such as meeting the minimum monthly repayment; not running up other purchases on the card; and being able to pay off the debt in full at the end of the interest-free period, Zinn says.
Credit providers know a certain number of consumers will fail to negotiate all these hurdles, either because they are not well organised, suffer ill health, lose their job or have their hours cut back. It’s how credit providers make their money, Zinn says.
A financial analyst with Canstar Cannex, Peter Arnold, says interest-free deals can work for people who are very well organised and disciplined.
“But the interest rates can go through the roof on these cards and they have fees that people need to be aware of,” Arnold says. “Compared to low-rate credit cards, it’s just so much more expensive to make further purchases on the card.”
For those who really need credit to make the purchase, personal loans may be a better way to go, he says.
Personal-loan interest rates are about 14 per cent a year. The loan should be paid off over no more than three years, so as not to pay too much interest.
With market watchers expecting interest rates to rise, Arnold says consumers should consider fixing the rate of interest on the loan rather than taking a chance that variable interest rates will fall. A fixed interest rate also makes budgeting easier, as the consumers know what the repayments are going to be over the life of the loan.
Unlike credit cards, the payments of principal and interest are divided into equal amounts over the life of the loan, so the borrowed amount is paid off at the end of the loan term.
Sometimes, consumers are so grateful it is interest-free that they do not negotiate on price, Lane says. “Many retailers now have these interest-free deals and consumers should shop around and get a better price,” she says.
If the consumer is really attracted to the interest-free deal, Lane says consumers should have a low-interest-rate card to pay off the high-interest card, just in case they get behind on repayments.
Low-interest-rate credit cards are available with interest rates of between 10.5 per cent and 14 per cent a year, Arnold says.
People having trouble repaying their debts can receive free financial counselling by calling 1800 007 007.
Beware leasing agreements
Those who are refused credit may be offered a leasing deal, especially if they are seeking to buy computer equipment. The principal solicitor at the Consumer Credit Legal Centre of NSW, Katherine Lane, says these leasing deals can be particularly dangerous.
“These are to be avoided because they are ultra-expensive, with often no right to buy it at the end of the lease period, despite what the lease company may say,” Lane says.
Typically, these lease agreements result in the consumer paying much more than the purchase price of the equipment being leased, without owning the equipment at the end of the lease term.
For business people and others who use the equipment for work there may be some tax deductibility but even then it’s an expensive option.
Check the expiry date on gift cards
Consumer group Choice says that more than half of the recipients of gift cards do not use the full value of the gift card before the expiry date of the card is reached.
About $1.5 billion is spent by consumers on gift cards a year but much of this money is wasted because almost all gift cards have expiry dates of between six months and two years. Choice looked at 15 gift cards from major retailers and found only one – from Bunnings – didn’t have an expiry date.
David Jones and JB Hi-Fi told Choice that they would honour or exchange expired cards and some others said they allowed grace periods, usually a month, after the card had expired. Some cards only state the issue date on the card, rather than the expiry date.
“Choice thinks there’s no good reason why gift cards cannot have much longer lives, or no expiry at all, ” says a Choice spokeswoman, Ingrid Just. She says the industry counts on the fact that many consumers do not use the gift cards before expiry dates.
When shopping this Christmas for gift cards, look at the expiry date, what happens if the card is lost or stolen and restrictions on which shops accept the card, as well as any potential fees and charges.
Choice says another option is to convert an unwanted gift card to cash or swap the gift card through the internet with someone else. A new website, cardlimbo.com.au, allows consumers to sell unwanted gift cards from about 100 different retailers at between 60 per cent and 90 per cent of the card’s original purchase price. The site also on-sells gift cards at discounts, usually of about 10 per cent.