Let me lay my cards straight down on the table (and I don't mean my credit cards). If you want to buy something, try to pay cash. And if you don't have the cash, think again whether you really need to make the purchase. This is a very simple, straightforward philosophy, and, while there are big-ticket circumstances where it's obviously not practicable - such as buying a house, funding an investment or establishing a business - if you stick to it wherever possible you shouldn't get into too much trouble with money.
The reason to pay cash and avoid debt are clear enough - interest is yet another cost to bear, and entering into debt puts you under a legal obligation to the creditor which can have serious consequences if you can't meet repayments. Namely, the creditor might take your purchase back or, worse still, might take other assets too.
Charge cards are a variation on the credit card theme and, in Australia, the two best known are Diners Club and American Express (although now American Express also offers credit cards). Where charge cards differ from credit cards is that when you receive your monthly bill you are expected to pay it in full.
Now, because you are supposed to pay your bill in full every month, charge cards officially carry no interest charges. If you do pay it out in full as expected, certainly, there is no interest. However, if you don't pay it out in full, one of a number of unpleasant things will happen to you. Your card will either be cancelled on the spot, or you will be charged very hefty penalty interest rates for a short period up until the time you either do pay it out fully or it's revoked, whichever comes first. In the case of American Express, in early 2001 they charged the greater of $20 or 3% of the amount outstanding per month, equivalent after compounding to a very solid 43% p.a. If this rate of interest wouldn't make you pay up in full, posthaste, I don't know what would. On its standard (green) charge card, American Express also charge a joining fee and annual subscription fee ($30 and $60 respectively).
As charge cards will not permit (or severely penalise you) for carrying debt over from one month to the next, it may be that they cause less long-term indebtedness than normal credit cards. Having said that though, some charge cards have no pre-set spending limits - you set your own. So, if self-control is not your strong suit, you could find charge cards the most dangerous plastic of all.
Store cards are a form of credit card issued by retailers like Myer/Grace Bros, Target, David Jones and Katies. Hundreds of different retailers in Australia issue store cards which are only for use in their stores.
The good news about store cards is that they attract no annual fees and have a good interest-free period - normally a maximum of either 55 or 60 days. The bad news about store cards is that they usually incur higher interest rate charges than credit cards. A difference of around 5% is not uncommon and it can be as much as 10%. Also, if you don't pay your account if full there are usually no more interest-free days until you do.
Now with some cards, shoppers are invited to buy big-ticket items where they are given, say, 6 or 12 months to pay, interest-free. What's often not pointed out is that if the item is not paid for in full during that period, then interest will be charged on the total price of the item and backdated to the date of purchase, regardless of how much has already been paid off.
Let's say, for example, you use one of these cards (or enter into some other in-house financing arrangement) to buy a $2,000 lounge suite on the basic of it being interest-free for 12 months. Let's also say that after 12 months you only manage to pay of $1,000. Under such an 'interest-free' arrangement you could then find that interest had actually been added to your bill - 12 months' interest in fact, starting at the date of purchase, and on the full $2,000, not on the $1,000 outstanding. To make matters worse, the interest rate would probably be very high - much higher than the average credit card or personal loan rate.
In this example, if the interest rate was 21% p.a. (and higher rates are possible) at the end of 12 months you would owe $1,420 (being the outstanding $1,000 plus 12 months' interest of $420 on the original purchase price of $2,000). And now you would have interest at 21% compounding on this new amount of $1,420 to contend with. Get the picture?!
I should make it clear though that with some stores offering interest-free periods, if, after the interest-free period has expired, there is still an amount owing, interest is only charged on that outstanding amount, not on the full purchase price. The salient point here, of course, is that you must make sure you know what the repayment conditions are and how interest is calculated before your enter into any of these purchase agreements. A bad one, ill-managed, could end up costing you dearly.
Lay-by is an old-fashioned but perfectly acceptable way of buying. It doesn’t encourage wild and impulsive consumption –the sort that puts you in the poorhouse – and, if you stick to the rules, you’ll pay no interest.
When you lay-by you pay a deposit and the store keeps the item while you pay off the rest of the money in installments. There’s a good incentive for you to pay off your debt because you don’t get your purchases until it’s paid for!
Terms and conditions vary from store to store, but generally you need a deposit of 10% to 25%. You’re then given two to three months to pay the balance, although it can be longer on more expensive items. If you run into financial difficulties most stores will extend the lay-by period by another month or two, however it is advisable to check the store’s policy. If you can’t or don’t want to complete your payments. Some stores will keep up to 25% of the cost of the item.