Wednesday, 25 May 2011

Understand the pitfalls of your credit card's Interest-free Period

by Rob d'Apice
Do you sometimes get interest charges on your credit card account when you think you shouldn't have? You may be falling into a common trap with your card's interest free period that's buried deep in the fine print.

Already bored? Well, mismanaging your interest free period could cost an average credit card user up to $70 every month.  That's a lot of cappuccinos.

What is an "Interest Free Period"?

It's the period in which purchases made from your credit card do not accrue any interest. It generally stretches from the day that the purchase was made to a set number of days after your monthly statement was issued (typically 10-15 days). It means that, if you pay off your monthly balance in full within the required window each month, you will never pay any interest on your purchases.

Like. But what's the catch?

It's simple: you don't always get an interest free period. This means you start racking up hefty interest charges from day 1 of your purchase. There are actually 3 completely different situations where the bank won't give you an interest free period, and it's important you know about all of them.

1. When you have an outstanding balance
It's very poorly understood by consumers, but it's the same with all cards: If you don't pay off your balance in full for a particular month, you will forfeit the interest free period for the following month.

Here's an example: Caroline spent $2,000 on her card last month, and had until 20 May to pay off the balance in full. Unfortunately, Caroline is addicted to poor quality drama and spent the week watching Offspring episodes back-to-back instead of paying her bills.  It's now 25 May.

Caroline can't stay mad at Offspring's delightful cast and crew for long

Caroline now has two problems:

  • First, her $2,000 debt is now accruing interest, costing her about $1.21 per day or about $36 in total if the debt runs for a whole month; and
  • Second, all her expenses this month now have no interest free period. If she spends another $2,000 this month on her card (assuming it's spread evenly over the month), this could amount to another $36 in interest charges. 

By forgetting to pay off her balance, Caroline could have cost herself up to $72 in just one month. Lesson: pay off your balance in full. You forgot? Pay it off right now anyway (that fixes problem 1), and put in any extra money to slip your balance into the black - this means new purchases will be 'instantly' paid off and won't accrue any interest. And make sure you pay off any remaining balance in full at the end of the month to avoid entering an interest charge spiral.

2. When you have a balance transfer
Did you dutifully obey the advice of Prosple Credit Card tip 3; that is, balance transferring your debts to minimise interest? Well, there's a big catch with balance transfers - don't spend anything on the balance transfer card when you get it. One big reason is that you don't get an interest free period when you have an oustanding balance transfer amount. That means you're instantly racking up interest on your brand spanking new card until you knock off the huge chunk of debt you wheeled over to it.

The second reason? It's about the debt-repayment order on a credit card, which is a blog-post in itself, but put simply: when you make a repayment to the balance transfer card, the bank will use your money to pay off the (very low interest) balance transfer amount in full before you can pay off any of the (very high interest, with zero interest free period) new purchases. Yes, it's unscrupulous. But now that you know, go ahead and be unscrupulous right back to them.

3. When you get a cash advance
Credit cards 101: don't get cash advances. Cash advances attract a higher interest rate. They often incur an instant fee over at least a few dollars, and sometimes much more. And, on top of that, they don't attract an interest free period.

How can I remember to pay?

Paying your bill off in full can be particularly difficult for us internet-o-philes, because the reminder of the monthly due date can be less obvious in your email inbox than in letter form.

We suggest putting aside 20 minutes each week to check in on your finances. This means checking your internet banking site to see if you have anything due, and processing any bills/payments/boring stuff that you need to get out of the way. A Sunday night often works well, or first thing monday morning to ease yourself back into the week.

Does this sound outrageously boring to you? You're thinking about it the wrong way. This 20 minutes per week is a small investment to stay on top of your money. Trust me, if you do it right, it's going to be the most lucrative 20 minutes of your week. More on this topic down the track.

What else could you do in those 20 minutes?

Wednesday, 18 May 2011

Calling all students: you may be eligible for a payment from the ATO

by Rob d'Apice
Did you receive Youth Allowance anytime between 2007 and 2010?

A recent High Court decision has concluded that students should be allowed to claim study expenses - like text books, home study expenses and depreciation of laptops/computers - as a deduction against income earned from Youth Allowance.

The ATO is now applying this decision retrospectively by adjusting the tax assessments of anyone who received Youth Allowance between 2007 and 2010, applying an additional tax deduction of $550 for each year.  If your marginal tax rate was (say) 15%, that's $82.50 that should be returned to you for each year - and potentially higher for a year where you may have started full-time employment.

If you have evidence that your study expenses were greater than $550, you can claim for a greater deduction - but you should contact the ATO now.

What do you need to do?

If you are eligible, the ATO should have already contacted you.  Haven't heard from them? Give them a call right now on 132 861 to make sure you aren't missing out.

If you've received your letter, and you haven't got evidence of study expenses greater than $550 in a year, you shouldn't need to do anything - the ATO will deposit any refund into your account before the end of May (as long as they have your bank details!).

What does this mean going forward?

If you're still a student, make sure you keep receipts relating to your study expenses.  At the very least, hang on to your receipts for textbooks, any electronics you may use for study (laptops, desktops, tablet PCs) and peripherals for those devices that you use for study (laptop stands, keyboard/mice, headphones, etc). Without these, you may miss out on deductions that you are entitled to that could end up saving you several hundred dollars a year.

Monday, 16 May 2011

Get rid of credit card debt with the Balance Transfer and the 20% Rule

by Rob d'Apice
Let's be clear: credit cards aren't for everyone.

So far in this blog, we've spent a lot of time focusing one (key) part of becoming more financially empowered: getting the right information on how to optimally use financial products.  But this can only ever be part of a money solution; as with many things in life, most of us know what we should be doing (not spending as much, eating better, exercising more, etc.) - but we still choose to buy things we can't afford / eat that whole tub of ice cream / put off going to the gym.

Managing debt is then part-scientific and part-behavioural; that is, getting the right information AND translating that into easy-to-implement principles to change your behaviour.

So: you have a big credit card debt?  We could say: "Stop spending and slowly pay it off over time.  Easy!" - but that doesn't help you (and, really, you already know you should do that).  So, here's our take on the best way to get out of credit card debt, mixing our knowledge of financial products and consumer behaviour.

Step 1: Balance Transfer your debt

Haven't heard of Balance Transfers?  Many banks offer a special deal if you transfer your existing credit card debt to their credit card; they give you a temporarily discounted interest rate on the transferred debt.  The saving can be very serious - from a 20-25% interest rate on your current card, to 0-6% on the new Balance Transfer card (generally for a period of 6-12 months).

How much could this save you?  On a $5,000 credit card debt, undertaking a Balance Transfer for a 12 month period could save you more than $1,000 on credit card interest.

Prosple will be the best way to find the right Balance Transfer deal for you; but for now, here are a selection of some of the good ones:

Step 2: Cut up ALL your credit cards

This is absolutely key. You've just transferred all your debt from your current card. That is not a blank cheque to start spending again. Cut up this credit card straight away. Then call the bank and cancel it. If any bank says "you can't cut up cards until you've done X, Y or Z": don't listen to them. They want to keep the temptation there for you, that's all.

Then: when your new Balance Transfer card arrives in the mail, CUT IT UP STRAIGHT AWAY. Spending on a Balance Transfer card is an absolute disaster. Interest-free periods are forfeited while you have the Balance Transfer. Any repayments you make go toward the Balance Transfer amount (low interest), and not your high-interest recent purchases - which is useless to you. Cut it up and get the debts out of your life.

Want to get really pro?  Instead of cutting them up, you can turn them into these nifty earbud holders.  Take that, Apple! (Thanks: Hamish)

(BTW, if you don't want to cut your cards because you need Visa or Mastercard facilities, you should get a Visa or Mastercard debit card that is linked to your savings/transaction account. We'll explore this more in a later post.)

Step 3: Set up a repayment plan (Use the 20% rule)

Your credit card debt isn't going to go away over night. It's going to take time and work. But you'll feel so much better when it's gone (and you can then start saving money, which means actually building wealth for the future).

Use the 20% rule. 20% of your earnings should go into repaying your debt. If you can stomach more, then set it higher. But set it and stick to it religiously. As soon as you get paid, transfer the 20% into your credit card. Yes, this will hurt, but all the pain will go away when you are debt-free. This strategy means that if you earn (say) $600 a week post-tax, you could pay off a $5,000 debt in less than 10 months.

Want to know how long it'll take you? Moneysmart, a recently launched government initiative to improve financial literacy in Australia, have a tool for calculating credit card debt repayment times. Have a play with it to see how soon you could be debt-free - or post in the comments below and we'll help you look into it!

Thursday, 5 May 2011

Always use American Express (except when the service fee is 1% or greater)

by Rob d'Apice
As a general rule, American Express cards earn more reward points than Mastercard or Visa.  Why?  American Express charges higher fees to merchants/retailers when you use the cards, so therefore they have more money coming in that they can return to you in the form of reward points. For this reason, it's better for you to always spend on an Amex when you can - you'll get more money back.

This advice used to always be true, but the tables turned on American Express in 2003, when the RBA introduced reforms aimed at reducing Merchant Service Fees (also called the credit card 'interchange fee'). One component of these reforms was the abolition of the 'No Surcharge' rule: merchants could now enforce a surcharge for using a credit card, and the surcharge could be different depending on the card.

In practice, I've found roughly half of the merchants I buy from don't charge a Service fee on any card. In these cases, always use your Amex. For the remainder, you should always use your Amex EXCEPT where the Amex surcharge is (roughly) 1% higher than the Mastercard/Visa alternative. The reason behind this is that Amex (roughly) returns 1.5% of the transaction total in reward points, whereas a visa or mastercard generally only returns 0.5% - the difference between the two being roughly 1%.  This obviously depends a lot on the cards in question, but is generally a good rule of thumb.

You may be thinking: "You want me to get a Visa AND an Amex?? You are downright loco!" Well, almost all the banks now offer credit card accounts where you get both an Amex and Visa/Mastercard linked to exactly the same account (only one credit limit, annual fee, etc.), so don't go around calling people loco so quickly, eh hombre?

Tuesday, 3 May 2011

Always redeem your reward points for flights

by Rob d'Apice
If you've been following Prosple Blog, you'll remember we recently blogged about the key reasons to get a credit card: namely, to make you money, rather than take it away. That was only one half of the story (actually, only one third, but we'll get to that in a bit). Once you get a card, you need to know how to use it right, and a bank isn't going to tell you this (it's not in their interest to do so, unfortunately).

So, we present to you a new Prosple series: the 10 top tips for getting the most out of credit cards. We'll be publishing these tips over the next few weeks, so keep your eyes on the prize.

Tip 1: Always redeem thy reward points for flights

This does depend somewhat on what card you're using, but it is almost always true that redeeming reward points for vouchers, cashback or products will return less money to you than spending them on flights.

The actual business strategy that leads to this outcome is a pretty fascinating aside. Putting someone in a seat that would otherwise be empty comes at almost no additional cost to an airline (perhaps the cost of the meal, as you can imagine that's not very pricey...). Airlines therefore had a very interesting problem: a product that is effectively zero cost, but isn't selling.

So airlines developed a variety of strategies for getting extra $ from these seats. One obvious idea is selling seats very cheap at the last minute. Another is packaging up discount 'mystery flights' where people buy a cheap ticket to an unknown destination (and the airline just chucks them on any empty flight when they rock up to the airport). Perhaps the most lucrative and successful, though, is the proliferation of frequent flyer reward points. The premise was simple: people who flew frequently accrued reward points and could use their points at getting some of these empty seats for free. The points were almost zero cost to give away, and yet have such a strong perceived value with consumers and incite such strong brand loyalty.

Nowadays, Frequent Flyer points are big, big business. Qantas (for example) sells Frequent Flyer points to other companies (like Visa, Amex, Woolworths, various restaurants, etc.) to give to their customers as deal-sweeteners. To prove the point, Qantas now makes more money from Frequent Flyer points than actually flying people:

BTW, EBIT = Earnings Before Interest & Tax, for you non-Finance nerds. Source
That's worth stopping and thinking about, really. If someone asks you "what does Qantas do?", what would you answer?

There's another interesting tidbit in the table above, too: Jetstar made double the profit of Qantas in the last financial year ($131m vs $61m). No wonder Qantas' current CEO is Alan Joyce, the man responsible for building Jetstar.

In any case, the key point for us humble consumers is that points generally go further with flights than products or cash. To put a nail in this tangent-ridden coffin, here is a comparison of how I can spend my Qantas Frequent Flyer points:

Cents of value per Qantas Frequent Flyer point
through different redemption methods

In other words, if I'm spending 1000 points toward redeeming an iPod (through the Qantas Frequent Flyer Store), I'll get roughly $5.90 of value.  Alternatively, if I spend the same 1000 points toward a return flight to LA, I'll get $12.50 worth of flights - that's nearly double how much I was getting when I was redeeming for an iPod. Simple, no?

Again, your 'common sense' instinct fires: "Why would return flights to LA be such better value?? Am I being duped somehow?"  Well, now you know: the cost for Qantas of providing seats on underbooked flights is MUCH cheaper than buying you an iPod.