Credit cards: keeping your expenses down

You may be tired of getting yet another notice from your credit card issuer that extraordinary economic times are forcing them to take extraordinary measures like:

• Hiking interest rates if you're late with a payment.
• Reducing your credit limit, even if you've never missed a payment.
• Slapping on new fees or higher rates if you miss a payment.

A recent report from Deloitte and Touche that offered credit card issuers advice on how to get through tough times, suggested that banks could be on the hook for up to $800 million in credit card losses in 2009. The report says a recent Bank of Canada report found that Canadians' debt-to-disposable income ratio had hit 130 per cent — higher than that in the United States. Deloitte says the last quarter of 2008 saw a significant increase in defaults on credit card debt.

There has been a marked increase in credit card debt over the past four years. In December 2004, Canadians owed $36.6 billion on their credit cards. In December 2008, the outstanding balance had hit $53.4 billion, a jump of 46 per cent.

But while Canadians' love affair with plastic is burning ever bigger holes in their wallets, the Bank of Canada report cited by Deloitte suggests that most households are well-positioned to manage their debt.

The bank says Canadians' debt-to-disposable income ratio was actually 127 per cent in the fourth quarter of 2008. That's up from 110 per cent in 1999 and is consistent with patterns seen in other developed countries.

Another report — from the Vanier Institute — found that Canadians' debt-to-disposable income level had hit 140 per cent by the end of last year. However, as of 2005, 73 per cent of Canadian households were paying off their credit balances in full every month.

Still, whatever numbers you play with, more money than ever is flowing through the banking system via credit cards. And while it may not be practical to keep the 2.6 cards the average Canadian family holds (the average American family carries more than five), in a block of ice in the freezer, there are steps you can take to reduce your expenses, if you do carry a balance.

Make your payments before the due date

If you pay your account in full by the due date, you pay no interest. However, if you are carrying a balance, making your payments earlier in the month will save you money.

Say you're carrying a balance of $5,000 on a card that charges 18.9 per cent interest, calculated on the average daily balance of your account for the month. We'll assume a 31-day billing period. Normally, you hold out and put $250 on your credit card bill two days before it's due. You were good this month and didn't charge anything else to your account. Your average daily balance works out to $4,975.81. You will be billed $79.87 in interest charges.

But say you managed to make your $250 payment on the fifth day of your billing cycle — maybe even before you receive your bill. Your average daily balance comes to $4,782.26 for an interest charge of $76.77 or a savings of $3.11.

Doesn't sound like much, but over the course of a few years, it adds up.

Can't come up with $250 that early in the month? If you make payments of $125 on your pay days — say the fifth and 19th days of the billing cycle — you still save $2.20.

Let's say you had to make a big-ticket purchase that month but didn't have the cash to do it — so you put it on your credit card. You put $475 on your credit card on the third day of your billing cycle. Since you're carrying a balance, you are charged interest from the day the purchase is made. Assuming no changes to your payment pattern — and that you don't pay off your new purchase right away — your monthly interest bill rises to $87.

But if you put off that purchase for three weeks, your interest charge is only $79.64 — or a savings of $7.37. You'd save $9.09 in interest that month if you paid off the $475 purchase the next day — and you would continue saving money until you paid off that $475.

You can play with other scenarios here.

Trade in your high-interest reward card for a no-frills, low-interest card

You love to travel, so you took out one of those cards that gives you points towards travel every time you use it. There's an annual fee and an interest rate of 18.9 per cent if you carry a balance.

If you use the card for your day-to-day living expenses, the points can add up pretty quickly and you'll have a ticket to ride in no time.

But you find that you don't quite pay off the entire balance every month. Pretty soon, you're carrying a balance of $5,000 a month. Even if you're employing the "make your payments early in the month" strategy, you're still paying nearly $80 a month in interest.

You change your tune and decide to put away the card until it's paid off. It'll take you 25 months to clear that debt. Over that time, you will have paid $1,052.83 in interest, without adding any more travel points to your account. Add the two years of annual fees, and your flight somewhere in North America winds up costing you around $1,500 after you pay the added fees associated with booking a flight.

Had you carried the same level of debt on a no-frills card that charged you 12 per cent interest on unpaid balances, it would have taken you 23 months to pay off the debt — assuming you behaved yourself and left the card on ice. You would have paid $606.74 in interest — saving more than enough for that North American flight. Maybe enough for a hotel room, too.

The Financial Consumer Agency of Canada has tools to help you decide which card is right for you.

Make more than your minimum payment

Making the minimum payment on your credit card may leave a little more money in your hands in a given month. It also goes a long way to boosting a bank's bottom line for a very long time.

We'll go back to that $5,000 balance on your credit card. Your card issuer says you only have to pay 2.5 per cent of your balance or $10 every month — whichever is greater. So you do — and do and do and do — for more than 25 years. Your $5,000 debt will be boosted by about $8,000 in interest charges.

If you bite the bullet and come up with $300 a month, your debt will be paid off in 20 months and you will have paid $845.93 in interest.

You can go through more scenarios by using Credit Canada's debt calculator.

Cash advances — don't do it!

You're out of cash and the bank account you use for your day-to-day banking is barely avoiding overdraft. You need a bit of money so you take $200 out of a bank machine, using your credit card account.

Your bank charges you interest from the moment you withdraw the money — even if you're not carrying a balance. That could cost you an extra $5 in interest. Add in service charges and you may have paid $10 to borrow that $200.

The bottom line

It's very expensive for you — and very profitable for a bank — to carry a balance on your credit card.

A line of credit — with a rate tied to the prime lending rate — is often a better option to help pay off your balance, unless you keep on transferring your credit card balance to your line of credit.

If that's the case, it might just be time to stick that card in a bucket of water and hide it in the freezer.