But paying just the minimum is a fool's paradise and our love affair with debt is costing us dearly. According to Reserve Bank data outstanding credit card balances - the amount accruing interest - jumped around $3 billion in the year ended March 2006. The independent research group Cannex estimates that cost us collectively an extra $596 million in interest last year. And the outstanding balances continue to grow. A reader's letter published in a major metropolitan newspaper this week highlighted how extreme the problem can become for undisciplined consumers. The author is opting for bankruptcy because of debts of more than $150,000 to credit card companies. At one stage this person says they had six American Express cards, eight Visa cards and four MasterCards and questions the aggressive marketing of new card offers - and the increase in available limits - by credit card companies. Now this was an extreme - and sad - case where a switch to a lower-paid job and broken marriages resulted in a debt spiralling out of control. Clearly a lot of anger was being directed at the companies the writer thought that had facilitated if not caused the problem. When you look at the Reserve Bank data the most concerning figure is probably the average card balance accruing interest which is now $1975 $150 higher than a year earlier. This is where the minimum amount issue looms large. Behavioral finance studies talk about the effects of "framing" in terms of decision making. The credit card statement is telling you the minimum amount it will cost you is the number X so it is not surprising a good number of people choose to just pay the minimum. It is similar with the superannuation contribution level set at 9% - the government has set that as a minimum and for a lot of people that also becomes the maximum. Where the minimum payment looks absurd is when you consider how long it would take to pay off a modest debt. Lets start with a card balance of $2600 and take the average minimum repayment required. On Cannex's estimates it would take 23 years and 5 months to repay the $2600 and if you were crazy enough to do this then you would have repaid a total of $8190. What this is suggesting - and what Cannex is advocating - is that perhaps we need to raise the minimum amounts that are required to be paid monthly. Australia does not tell the credit card companies what minimum repayment levels should be so it is up to the individual companies to set minimum repayment levels but the average is around 2.36% of the balance. In New Zealand the average is considerably higher at 4.25%. In the US the federal government has moved to mandate that the repayment minimums must include a 1% principle component. That move alone effectively doubled minimum repayment amounts because in the US the minimum repayment levels were just covering the interest charges. So think of it as an interest-only loan. The UK government has also just moved by adding "health warnings" on credit card statements and the same idea has been mooted in Australia but is yet to win broad support. There is no doubt there has been massive change in the credit card market in the past decade and a lot of it has been positive for consumers but the burgeoning debt issue clearly is not in the consumer's best interests and longer-term will hurt the reputation of the finance industry if it does not take action to help people avoid the debt trap.
And if you are someone who pays the minimum amount off the credit card each month understand why the minimum repayment figure should be flashing danger signs. Robin Bowerman
Principal & Head of Retail, Vanguard Investments Australia
www.vanguard.com.au
21st-July-2006 | 
