So what's the catch?

Perhaps the biggest trap of all for some credit card users is the fact that credit cards allow you to spend money that you don't necessarily have. The convenience of "buy now pay later" is not so convenient when you simply can't afford to pay at all – now or later.

And of course, credit comes at a cost – the main one being interest. Other costs can include yearly fees, and one-off transaction fees and charges. For example there may be a charge if you purchase an item in a foreign currency, if you spend more than your agreed credit limit, or if you use your card to withdraw cash (a cash advance). Depending on the type of card you have and the way you use it, these costs can make credit cards an expensive way to make purchases.

Maximising benefits, minimising pitfalls

In order to make the most of the benefits of credit cards while minimising the potential pitfalls, you need to:

1. Get to know your own spending habits;
2. Get to know the different types of cards on offer and how they work, including the way interest is charged and the other costs involved.

Ask yourself this...

Once you've kept a spending record over a couple of pay cycles, have a look to see what it tells you about your spending habits. Ask yourself the following questions (if you've also created a budget you should now be able to answer all of these questions):

• How much of your spending is on essential expenses like groceries, rent, utility bills and debt repayments?
• How much of your spending is on non-essential 'want' items (that are avoidable costs) like magazines, buying lunches at work, traffic and parking fines, buying new clothes just to have latest season's colours, new ring tones for your mobile phone, or upgrading to a bigger TV?
• Do you ever spend more than you can afford to repay over a normal pay cycle?
• If you already have a credit card, do you use it to pay for everyday items or do you use it only for larger, one-off purchases?
• Do you pay your credit card off in full every month, or do you carry a regular debt on your credit card (ie do you pay only the minimum payment due when your bill comes in or just a portion of your overall debt?)
• What sort of fees and charges are you paying for your credit card?

Knowing how you spend your money, and whether you might already be spending more than you can afford, is a crucial first step in being able to determine which type of credit card is likely to suit you best (and whether you even need a credit card at all). The next step is to get an understanding of all the types of cards that are out there.

2. Different cards and how their features work

There's no shortage of credit cards on offer in Australia, and just about every card seems to offer something different. Before you sign up to a credit card, or if you're thinking of changing the type of card you have, you'll need to get to know what's out there and how the various types of cards work. In this section we explore some commonly available card types as well as some common card features.

Low-rate credit cards

In the current market, low-rate credit cards are typically those that offer ongoing interest rates around the 8-10% per annum mark (versus more standard rates that tend to be upwards of 16% per annum).

The trade-off that you might pay for this lower rate is that they tend not to have all the 'bells and whistles' as a result, for example there may be no interest-free days on purchases, and/or no reward programs.

Interest-free days

Some cards offer a set number of interest-free days on purchases – for example up to 45 or 55 interest-free days. What this usually means is that when you make a purchase, you'll have up until the next statement date (or in some cases your payment's due date), before interest will apply to that purchase.

There are a number of things to note about interest-free days:

• If you always pay off the full balance of your credit card whenever a payment is due, you will not incur any interest on your purchases under the interest-free days system.
• However, if you don't pay the balance in full (for example if you pay only the minimum payment), interest will be charged. Depending on the card, interest may apply to the entire balance of your card up until you pay off the balance in full (so essentially, you may no longer have any interest-free days on any purchases until the entire balance of the card is paid out). See below for more on paying only minimum repayments.
• The trade-off for having the potential benefit of interest-free days is that you'll probably pay an annual fee for the card. Typically this could be anywhere between $30 to $100, or upwards of $150 for many premium cards (such as various 'platinum' cards, etc).

Minimum payments – what they're costing you

Many cardholders opt to pay only the minimum payment due when they receive their credit card statement, rather than paying the balance in full or paying more than the minimum. But only making minimum payments can prove costly in the long run. The example below shows how long it will take to pay off a $1000 credit card debt through minimum payments only.

As you can see, the debt will take more than 10 years to pay off – and that's with no new purchases being made. The total interest paid over that time was $889.36.

Reward programs

A number of credit cards offer reward programs that allow you to earn reward points with every purchase you make. These points can be redeemed in a number of ways depending on the card issuer, for example in the form of gift vouchers with approved retailers, frequent flyer points, or consumer goods.

Some are effective programs that truly do 'reward' you. But it's a good idea to do your sums – here are some factors to consider:

• The cards that offer rewards programs usually come with an annual fee for the privilege, and unless the rewards are items that you would usually purchase, then you might be paying for rewards you don't use and perhaps don't even want.
• Some rewards schemes offer bonus points if you shop in certain stores. But if you're shopping there purely to earn the bonus points when you could get the same goods cheaper elsewhere, you might be paying a premium that effectively cancels out your bonus points.
• If you're purchasing goods using your credit card purely in the hope of accumulating more reward points (rather than just using cash or other methods of payment), make sure that any annual fees you pay, plus any interest you might also pay on all those credit card purchases, don't actually cancel out the value of the reward altogether.

Store cards

Store cards are a type of credit card issued by specific retailers. They may give you access to in-store specials at the issuing store, or interest-free deals (see below) on certain purchases. However, store cards often carry a higher rate of interest than cards issued by financial institutions and other credit card issuers, and in addition, some come with annual or even monthly fees.

And while a store card may offer a convenient way of purchasing items in a specific store or chain of stores, consider whether the prices charged in that store are giving you the best deal – are you actually paying a premium just for the convenience of being able to use the card?

Interest-free deals

We've all seen the ads and we've all seen the banners – "12 months interest free",or "pay no interest for two years". In some stores, if you've got a card specific to that store or if you take out a branded credit card, you may be offered interest-free deals on larger purchases (usually on items that cost around $500 or more). But 'interest free' isn't always as good as it seems.

During the interest-free period, even though you're not paying interest on your purchase, you'll usually be required to make repayments on the item itself. But therein lies a potential trap. The set repayment amount is rarely enough for you to have paid off the item in full by the time the interest-free period is over, at which point you could face a very high rate of interest, based on the full amount of the original purchase price (even if you've paid most of it off by then), and sometimes even backdated to the original purchase date. Always read interest-free contracts in full before you sign up.

Honeymoon rates on balance transfers

Some credit cards offer low interest or even no interest for a set period if you transfer over an existing balance from another credit card – the idea can be attractive, especially if you're currently paying a high rate on an existing debt.

But what happens once the 'honeymoon' is over? In some cases, the relief is only temporary, and the sting is substantial. Having been lured by the promise of a temporary break from interest payments, many cardholders suddenly find themselves hit with very high interest rates – perhaps costing more in the long run than if they'd simply transferred their balance to a card offering a low or moderate ongoing interest rate from day one.

What's more, in some cases, when the higher interest rate kicks in, it's applied not only to the purchases you've made since you transferred your existing balance, but also on the existing balance itself. Indeed, those seeking temporary respite from high rates may find themselves paying even more interest than they were on their original card debt.

As with all credit card products and features, reasonable options do exist - the trick is to read the fine print carefully and understand what you're getting.

An alternative to credit cards – the new debit cards

Of course, it may be that you don't really need a credit card at all – a product such as a debit card can be a suitable alternative to credit, and one that sees you using your own money rather than borrowed money (which, let's not forget, is exactly what credit is). Once upon a time debit cards operated just like a standard ATM card, in that you used them to purchase goods at EFTPOS or ATM facilities, or to withdraw cash, all directly from your account. These days, some debit cards can be used more like credit cards in that you can use them to make purchases over the phone or internet. So now, it's possible to access some convenient payment options that used to be the exclusive domain of credit cards, all with the relative security of knowing that you can only spend money you actually have. Note though that debit cards can attract a monthly fee.

• Cash advances (when you use your credit card to withdraw cash) can incur upfront fees as well as very high rates of interest (not only on the amount of cash advanced to you, but on the entire balance of the card). What's more, that interest rate can apply from the day you obtained the advance right up until the day you pay your entire balance in full.
• Going over your card limit can also be costly. Once upon a time transactions were declined after you reached your card limit. These days, it can be possible to keep spending, but doing so could see you getting hit with a fee for going over your card limit and possibly even penalty interest or loss of interest-free days.
• Missing a card payment generally results in a late payment fee, so be vigilant about paying your bill on time. If you pay your card payments by direct debit from your bank account, arrange for the direct debit to be withdrawn a few days before the due date of your bill to allow for any processing glitches that might delay your payment.

These are just some of the additional costs that can be associated with credit cards. Generally, the more closely you monitor your credit card use and the more vigilant you are when it comes to sticking to your spending limits and paying your bills on time, the more you'll minimise your chances of getting unexpected surprises on your next credit card statement.

But as with all aspects of taking out a credit contract, make sure you read and understand the fine print. Only then will you know what the ongoing cost of the card is likely to be, and only then will you know what your responsibilities are when it comes to managing your card.

For more information

For more on this topic, have a look at the fact sheets and tools already available at www.moneyminded.com.au:

• 10 tips for a healthy credit card
• Credit – some everyday options
• Keeping your cards safe
• How to prepare a budget
• My budget worksheet (xls, 35kb)
• Spending leaks
• Spending Leaks Calculator (xls, 41kb)

Here are some other helpful resources, designed to give consumers practical information about credit and making decisions about credit:

• www.fido.asic.gov.au - the Australian Securities and Investments Commission consumer web site;
• Smarter Banking – Making Credit Work for You, a booklet produced by the Australian Bankers' Association, available for download from their web site at www.bankers.asn.au.