Sunday, July 01, 2007

Trapped by plastic

This is an article featured in The Star Weekend Focus 30 June 2007. It describes the danger of using credit card if one doesn't have the necessary discipline.

A survey carried out by a local university has shown that 11% of bankruptcy cases were due to credit card debts and 8% of bankrupts were aged between 20 and 30.

When her parents announced they were going to cut her off financially, Sarah, 27, a flight attendant, was literally floored.

“For 27 years they picked up the tab for everything from cigarettes to cereals,” she admits.

“But when they found out Derek (the boyfriend they weren’t particularly fond off) and I were living together in the apartment they had been footing the rent for, mom and dad went ballistic and revoked all monetary privileges,” reveals Sarah.

“I had charged four credit cards to the tune of RM11,000, and that debt alone was overwhelming me. I couldn’t imagine having to pay all of my own bills, plus the credit card debt.”

Cut yourself loose: If your plastic has landed you in credit card hell, it’s time to cut it out of your life (model posing). — RAZIQ ABD SAMAT/The Star

In the end, Sarah took some pretty extreme measures and paid off her debt in four months.

“I hauled every single thing I owned out onto the lawn and sold it. When I was done, my possessions amounted to just two boxes of clothing and one box of personal papers and mementos. Then I called up each credit card company to work out deals, and a lot of them let me ‘settle’ my debt for slightly less than I owed or at least cut me some slack on miscellaneous fees and interest.”

Many young people are making similar credit mistakes without the safety net of wealthy parents to fall back on. In school, you have home economics classes that teach you how to bake a cake and how to make your own orchid plant holder, but no one ever sits you down to explain responsible credit maintenance.

A shiny new credit card promises the young adult a whole new world, but no one thinks about the potential pitfalls. Credit facilities allow people to spend money they do not actually have, but will eventually come into. Problems arise when you spend more money than you will come into.

“Credit cards are a good tool when put to the right use. A consumer doesn’t need to bring along a lot cash to purchase goods or services. For a business person, he has less receipts to compile when it comes time to submit his income tax return form, because most of his business expenses would appear on one credit card statement,” points out Hazel Ong-Archibald, 35, an agency manager with CIMB Wealth Advisors.

“The disadvantage is people can get so carried away with the concept that they can pay later that sometimes they forget to live within their means.”

A collection agent tells me the plight of one debtor he was assigned to track down: in his first year of owning a credit card, the man charged RM12,000. Twenty years later, the poor chap still hadn’t managed to settle it. Now, as a result of several late payment charges, interests, etc, his bill has ballooned to more than RM20,000. He was 56 years old.

“When I mentioned bankruptcy, he didn’t seem to care. It had become that bad. I felt awful asking him to pay up,” the collection agent says.

As Shannon, 24, a web designer, discovered three years ago, credit is not free. Like many others, she started out using her card reservedly – the occasional RM60 lip gloss, for instance, which she paid for immediately upon receiving the bill.

But then along came Christmas.

“I remember thinking to myself: I can barely get by on my measly salary, how am I supposed to buy anyone presents?” Shannon recalls.

“My three-month-old credit card seemed like the best invention in the world, so I swiped for all my presents.”

The next thing she knew, Shannon was staring at a bill of RM4,000, twice her monthly take-home pay. She panicked, and then she saw the minimum payment box – RM200 – and breathed a sigh of relief. Three years later, she still hasn’t managed to settle her outstanding balance.

“I’m being hit with interest every month,” Shannon laments. “I felt really good being able to give everyone nice presents for a change. But I didn’t know that good feeling was going to cost so much.”

According to Ong, if you only pay the minimum, you would be charged an interest of 1.5% per month or 18% per year for the outstanding balance.

“The interest payment compounds over time, and that is how many people get trapped in credit card debt,” she explains.

Some retail outlets tout zero interest, easy payment schemes using a credit card. But there is a catch. Say you want to snap up a new sound system. Instead of signing a slip for RM3,000, you sign an agreement saying RM300 will be charged to your card every month for the next 10 months. If the cardholder does not pay in full when the statement comes, then her purchase under the “Zero interest payment” scheme will be subjected to 18% interest per annum.

On top of that, there is usually an administration fee for signing up for the scheme.

Sabrina, 30, managed to service the first three instalments on a RM1,500 sofa bed, but then met with some other incidentals and couldn’t make the payments on time anymore. At the end of the 12 months, she was paying interest rates on seven months for her new sofa.

“Then again there was no way I could afford to shell out RM1,500 out of the blue just like that,” confesses Sabrina, a stylist.

Easy payment schemes like these offer a lot of convenience but it takes a great deal of discipline to make it work for you. While those who take up hire-purchase loans are protected under the Hire-Purchase Act 1967, there are no specific laws to protect those who take up easy payment schemes.

The rate of interest for the easy payment scheme is likely to be higher than that of hire-purchase since the Hire Purchase Act puts a limit on the maximum interest rate that can be charged. If you always have an outstanding balance on your credit card bill, these schemes are definitely not for you.

Banks these days are practically throwing cash and free gifts at consumers, but stay alert to changes in the terms and conditions of your credit card agreement and read the fine print.

One bank sent out cheques of RM5,000 to cardholders. Once the cheque is deposited into the cardholder’s savings account, a handling fee of RM150 is charged. Interest of 18% per annum on the outstanding balance is charged if the cardholder does not settle the monthly payment in full.

Sometimes, as customers approach their limit, the credit card company may offer to raise the limit to encourage increased spending and debt. To reel in young professionals aged 25 to 29, some banks even lower the qualification criteria.

At 18% per annum, a credit card loan is way more expensive than other types of consumer lending. You can become a bankrupt if your debt mounts to more than RM30,000. Until you are discharged as a bankrupt, you will not be able to apply for a loan.

A debt management speaker once said: “Just keep one card in case of emergency, and even then, keep it frozen in the refrigerator.”

Although this had everyone laughing, he emphasised that he was serious. So, if you have a credit card for every bank in town, it’s time to pick up the phone and start cancelling.

With interest rates at nearly 50% less than those of credit cards, some personal loan packages by banks are being viewed as an ideal way to settle your credit card debt as you repay the personal loan in fixed instalments over a period of time.

“You must, however, pay off the debt with discipline and not allow it to compound again due to an inability to service the loan repayment,” says Ong. Otherwise, you could find yourself in the same boat as Preetha, 28.

The legal assistant took a personal loan to settle her credit card debt of about RM10,000 and kept the card. As you might have guessed, it wasn’t long before she started using the card again.

“It started innocently enough,” recalls Preetha. “I used my card to pay for lunch, promising to repay it as soon as I made a withdrawal. But I never did.”

With a fixed commitment to her personal loan, Preetha found herself only able to pay the bare minimum on her credit card. It wasn’t long before she ran up a RM1,000 debt on her card, and she knew it would keep rising. She had no choice but to cut up her card.

“I’ve managed to bring it down to RM700 so far. As soon as it’s down to zero, I’m cancelling the card and getting a debit card instead – no more excuses then!” she promises.

Debit cards have become quite fashionable these days because they are virtually risk-free. Basically, they work like a prepaid card: You deposit RM1,000 in your account, and you can do up to RM1,000’s worth of spending.

You simply cannot overspend unless you top up your account. With MEPS Cash and other debit card facilities, people can learn to curb their spending, live within their means and stay out of debt.

Source: Consumer Association of Penang in the book Money Matters for Young People (2006).

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