Ask the expert: Should I use a credit card?
Our ask the expert financial FAQ series with Paul McGerrigan, CEO of Loan.co.uk, continues.
The aim of the series is to educate consumers, allowing them to make informed choices on their spending decisions, with a different question being answered each week.
Q: Should I use a credit card?
A: Credit cards are a favourite of people when they are making small to medium sized purchases and the money spent on credit cards is increasing again as people get a bit more relaxed with their borrowing and debt levels.
Credit cards are an easy and convenient way to spend money. It is safer than carrying cash, covers you in an emergency and provides extra security when making purchases under Section 75 of the Consumer Credit Act 1974 (if a product over £100 is purchased using a credit card the credit card company is jointly and severally liable to the debtor for the purchase)
If you pay the balance off every month and have a plan to manage your borrowings, credit cards can be used as an effective part of your overall personal budgeting and finance. They can also help you build up a good credit score. Clearly using credit cards, has a range of advantages, but they can also be very dangerous if not used responsibly.
The biggest danger with credit cards is that they allow you to have access to credit without having to go through the rigorous affordability checks you would have to go through when borrowing for a mortgage, second mortgage or unsecond mortgage. Also, because the minimum monthly payment required to service the debt is only 3% and in some cases 2% of the monthly balance people can unwittingly build up significant balances almost without realising it.
With it being relatively easy to apply and be accepted for multiple credit cards, it is not uncommon for people to run-up high levels of unsecured debt and get drawn into funding a lifestyle outwith their means. This accumulated debt can very quickly, or over a longer period of time, build up to the point were it starts to put pressure on overall monthly finances.
Just paying the minimum monthly payment for a long period of time and never actually addressing the capital amount borrowed, can result in people paying back significantly more than the original amount borrowed. Take the example of a £1,000 balance on a credit card with a 16.9% charge rate. After 3 years only paying the minimum monthly payment, (I have assumed 3%) you would have paid back approx £830 and still have a balance of just over £550 on the card. After 5 years you will have paid back over £1,160 and still have a balance of over £370 on the card. So as you can see if you are not paying over the minimum monthly payment this debt can run and run. Now imagine if the borrowing was £10,000 or more, which for many people it can be! This is where the challenges come in.
It gets to the stage where even covering the monthly cost can start to bring increasing financial pressure. At this point, my advice would be to speak to someone to consider the financial restructuring options available to you. By consolidating your credit card debt into a single loan, you can give yourself an affordable monthly payment and can be debt free within a number of years. Remember to take into consideration the amount you will be paying back in total from the loan. If you do this cut up the majority of your cards and try to minimise your credit card borrowing unless you really do have an emergency.
In summary, credit cards are an effective way to manage your spending if you use them in a responsible way.
However if your spending gets out of control over a short or longer period of time, you can very quickly find yourself drowning under a mountain of debt, with can bring major implications for your financial position and ultimately your credit rating.