Credit cards as a method of payment, are more popular among Canadians than ever. In fact, a recent survey by the Bank of Canada reported that credit card use was on the rise, in terms of number and value of payments, while both cash and debit card use declined. And the increase occurred across almost all product and service areas, from gas to groceries, to meals and entertainment. What's more, credit card use increased across all age, income and education level groups.
The following is a client story from Alison Petrie, our bankruptcy trustee in Oshawa. Alison talks about the long slow cycle into debt that one couple experienced as a result of their reliance on credit cards to balance their budget, despite being so careful with big financial decisions.
Last week I met with a young couple, John and Michelle (not their real names). John works full time but with 2 pre-school children at home, Michelle only works part-time. Knowing that their income was limited, they made as careful a decision as they could on the big purchases. Wanting a home for their family, they chose to live in a smaller house that they purchased 3 years ago for $150,000. Today they owe $118,000. They own only one car (a new one), but they were happy that their payments were lower than what they were paying for repairs on the old one, and with only one car, they needed to make sure it was reliable.
Despite this, John and Michelle came to see me because they have $70,000 in credit card debt. They just couldn’t understand how they had managed to accumulate that much credit card debt while trying to make good financial decisions around their home and car.
Unlike your mortgage and car loan, debts like credit card debt and lines of credit are considered revolving debt. With revolving credit you can use the funds when you need them, don’t have to make fixed monthly payments and as you pay it off you can use it again. The problem with this type of flexible credit is that it can, and does, quickly get out of control and that’s what happened to John and Michelle.
Here are some danger signs John and Michelle could have watched for.
Credit Card Danger Signs
- Not knowing your monthly expenses. Before John came to see me, he contacted a financial counsellor through his EAP at work and the counsellor asked how much the family spent in various areas. John didn’t know so he and Michelle got together one weekend, wrote it down and added it up. John was horrified to see they were spending more money every single month than they earned.
- Using credit to create cash flow. John and Michelle were able to spend more than their income by using credit. If there wasn’t enough money in the bank account, they paid for necessities like food with a credit card. They thought this was just a temporary problem until payday.
- Charging more than you are paying off. Most people don’t look at how much they owe on a credit card, they only look at the minimum payment. The minimum payment is very small and manageable, at least in the early days. For 2 years John and Michelle made the minimum payments on the cards quite easily. Because they focused on the payment, rather than the balance, they didn’t notice that every month they charged more on the credit card than was paid off, and that they were getting deeper in debt every month.
- Stalling one creditor to pay another. This is commonly known as "robbing Peter to pay Paul". You take a cash advance on one card to pay the minimum on another. Eventually, you skip a payment on one card this month and skip a payment on another card the next month. Soon the creditors start calling about the skipped payments. For John and Michelle, this is when the stress levels really began to rise.
- No savings or emergency plan. The reason John and Michelle turned to credit cards each time a small cost came up was because they didn’t have any cushion in the form of savings to rely on. Without an emergency fund, John and Michelle couldn’t weather the impact of even small demands for cash. Life will always throw you curve balls. You must have some savings so you can pay for non-regular, random occurrences. On the surface their decision to spend less on a car payment rather than car repairs seems sensible, but the car payment comes out of their bank account and further depletes the cash available for other unplanned costs like a wedding invitation, dental bills or house repairs.
- Running out before payday. The final straw for John and Michelle was the fact that eventually they found themselves short of cash each and every payday. This is not an uncommon side effect of continuing to use credit. As your credit card bills increase, so do your minimum payments. Now debt payments take up an ever increasing share of your paycheque. In extreme cases you go out and get a payday loan to buy groceries because your paycheque is going to pay interest on your credit card debt.
- Consolidating debt and racking up the mortgage. Desperate to reduce their credit card debt, John and Michelle considered a debt consolidation loan. The problem was, with $70,000 in credit card debt and only $30,000 or less in home equity, a debt consolidation loan was only going to take care of part of their debt. And if they didn’t deal with all the credit card debt, John and Michelle were deathly afraid they would end up losing their home.
That’s when they came to see me. We talked about making a consumer proposal which would allow them to offer a deal to their creditors to settle all of their $70,000 in credit card debt for roughly $35,000. This amount was based on the equity value in their home, plus an amount based on John’s income which was fairly good. They were able to spread the payments over five years. When combined with some budgeting advice, John and Michelle found they were able to balance their budget and even get ahead on their savings, without using credit cards to survive.
If you are paying of your balances in full each month, using a credit card to pay over cash makes a lot of sense. You earn points, there is no need to carry large amounts of cash and there is some added security in being able to cancel your card if your wallet is lost or stolen. However, these benefits are quickly overshadowed by interest costs if you can't pay off your credit card debt. Credit cards can swiftly morph from an ease of payment tool into a way to make ends meet. In effect, your credit cards change from a 'credit' tool to a 'debt' tool.
Do any of these “danger signals” or “symptoms of financial problems” sound familiar? If they do, give us a call so we can help you develop a plan to eliminate your credit card debt and start over financially.
CREDIT DANGER SIGNALS
- Don’t know real monthly expenses.
- Using credit to create cash flow.
- Charging more per month on a credit cards than you are paying off.
- Stalling one creditor to pay another (robbing Peter to pay Paul).
- No savings or emergency fund.
- No money before pay day.
- Consolidating loans.