Interest rates have risen and fallen dramatically over the last few years. But credit cards have seen comparatively tiny reductions in their rates. The good news? You can save heaps on your credit card bill just by being smart about using your card.
People pay literally billions of dollars a year in interest from their plastic – making a credit card one of the most expensive forms of borrowing around. But it doesn’t have to be that way. The reason they pay so much interest on their cards is because they use them incorrectly.
Interest rates are irrelevant when compared to how a credit card is used and whether the credit card utilised suits an individual’s patterns of use.
There are basically two types of cards.
The normal credit card
The first is generally the most often used it has no annual fee and has an interest free period of up to 55 days after a credit card purchase has been made. After that period, however, interest charges are extremely high, normally around 19%. This is the card you will be most familiar with, it has a credit limit preset and you normally only have to repay 5% of the balance owing each month. The remaining balance sits there charging you interest.
What most people don’t know is that when you withdraw cash, instead of receiving a period of interest free days, interest is charged from day one.
Furthermore, cash withdrawals are the last debt to be paid off so if there are other debts on the card and you think you have paid off your cash advance a day later and escaped the expensive interest charges you will find you are just paying off another debt on the card, leaving the cash advance there to accumulate interest. In most cases, the entire card must be paid off to avoid such charges.
The Charge Card
This leads me onto the second type of card. It’s called a Charge card and although they look very similar to a credit card they are very different.
Firstly, everything you spend over the course of the month is charged in the normal way but at the end of the month you must pay the balance off in full. In this way you are getting full use of the banks money for up to 55days. Then you pay it off in full and the process starts again. Now often this type of card will have an annual fee. The most famous of the cards are the American Express and Diners.
Personally I use an American Express and a Natwest Premier Charge. Now the reason I use two cards is a concept called “factoring”. Factoring is all about cashflow and you should be getting to know by now how highly I regard cashflow.
Now before we move on you need to understand this 55 days interest free period and its relation to statement dates.
Important dates in the credit card cycle
Once you receive your card there are two vitally important dates to remember. They are so important I actually alarm them in my phone each month. The first is the statement date and the other is your direct debit or payment due date.
Statement date is simply the date your statement is issued. All transactions up to that date will be due on the next payment due date and all after will be on the following month.
Now your payment due date in the case of a 55 day card will normally be 24 days after the statement date. 31days in the month plus 24 days till payment. A 45 day interest free card will be 31 days plus 14 days.
OK — so why do I have a charge card. It comes down to factoring.
The concept of factoring
Factoring is most often used in business to create immediate cashflow. A business will invoice a client but not receive the payment for say 30 days. So the business will go to a factoring company who will pay the invoice immediately minus around 7-9% commission. So basically for this fee you get to use the factoring company’s money for the 30 days.
Now with a credit card you spend the money but don’t pay for it until the payment due date. So effectively you get to use the finance company’s money for however many days that is. It keeps the cash in your account but doesn’t cost you anything to do so.
Now the only thing left to consider is the annual fee on the charge card, because they can be hefty. I have the Amex Platinum which costs me £275 and the Natwest which is £195. So that’s £475 per year or £40 per month. So I need to make a judgement call on whether I think it is worth £40 per month to use this facility. For me it is because I also use my Natwest Charge to buy houses and I get Air Miles points for it and it also comes with a £10,000 overdraft, the Amex I use for all my travel booking. Both of these come with other features which I use such as the travel insurance and purchase insurance.
Now the other option is to take the first type of Credit card and use it in the same way as a charge, set up the direct debit for the full amount each month. If you do this you effectively will be using the banks money for nothing. It feels so good to get something over the banks for once.
Now let’s look at why I have two charge cards rather than one.
My statement date on the Natwest Charge is the 17th of the month and it is direct debited on the 6th of each month. The Amex is the 29th and the direct debit is the 10th of the month. So I use the Natwest between the 17th and the 28th and the Amex between the 29th and the 16th of the month. This means I am maximising my interest free days from each card.
Now on the whole this formula works fine but sometimes the Amex is not accepted so I then use the Natwest but I accept this as part of doing business.
I use my credit cards for every purchase imaginable, another feature about cards is that when you purchase something using your card, if say the Merchant doesn’t provide you with the service or product you ordered then you can charge the amount back and then it is on the merchants back to prove they gave you the service. Try doing that with cash. They are a lot less likely to care about what you think about their service once you have paid cash. It is also a much safer way to shop online.
Spend your money twice.
Credit cards also allow you to spend you money twice, firstly if you buy something using the card (that’s the first time) and then when you get your statement (that’s the second time). So once the statement comes in it allows you to track all your expenditures but it also reminds you of those stupid purchases you make. This is a great thing if you are trying to develop better spending patterns.
Psychology of a charge card
I prefer using Charge cards because every time I make a purchase I must remember that I have to pay for it at the end of the cycle. No excuses I must come up with the cold hard cash. This means that discretionary spending becomes harder because I cannot just say I will pay it back next month. It creates a simple discipline that supports my lifestyle goals.
Floor Limit on your Spending
The only other thing I do is that I place a limit on what I think about. What I mean by this is that I don’t think twice if the purchase is under £300. I can make as many purchases as I want up to £300. Anything above £300 I will sleep on before I buy. Now maybe you are not at £300, I actually used to do it back in Australia at $50. So this meant that things like food shopping and restaurants I didn’t have to worry about. Obviously as your portfolio gets bigger and you can afford more you can raise the spending limit.
Now I still sometimes regret the purchases I make when I get the credit card statement for the purchases under £300 but I don’t stress about the adverse affect it may have on my lifestyle goals.
Finally, I look at it this way, every wealthy person I know has a charge card so their must be something about the charge card that works for them. Likewise every financially struggling person I speak to has multiple credit cards, it must be something they are doing that doesn’t work for them.