Nation in hock should wean off credit cards

THE average financial adviser will not tell you this, but one investment beats virtually anything else. Its effective rate of return is about 27 per cent. Yes 27 per cent. It is achieved by making sure you pay your credit card off by the due date every month.

If you don’t, you get hit with a 20 per cent interest charge backdated to the date of the purchase of each item. Given that the return on the “investment” of paying the card off is tax free, and most people are on a 33 per cent marginal tax rate, it amounts to a return of 27 per cent.

Let’s put it this way. That 27 per cent is what you would have to return on any other investment if you were silly enough to make that investment without leaving enough money over to pay your credit card off. Economists call it opportunity cost.

And many are paying it. A report this week from the Senate Economics References Committee tells us that nearly two-thirds of the $50 billion owed on credit cards in Australia at any given time is accruing interest. That debt is on average held by 35 per cent of issued credit cards.

The majority of Australian households now have a net credit card debt. When you combine those two facts the conclusion must be that many households have one or more cards in control and one or more cards heavily out of control.

Total credit-card debt has risen by nearly 50 per cent in the past 10 years. We are a nation in hock.

The people who make the money, of course, are the banks and the big (mostly foreign) corporations who run the credit cards. The people who lose are the poor sods who get beguiled by advertising and the call of instant gratification and cannot pay their cards off.

There is probably a quick economics PhD thesis in the correlation between the rise of credit cards and the fall of home ownership. Once young people fall into the credit-card debt trap, the prospect of saving for a deposit on a house evaporates.

The latest Reserve Bank figures show Australians put $24.8 billion on their cards in October this year — about $300 billion a year, or about one fifth of GDP.

The committee questioned why credit card interest rates over the past five or six years had remained stuck at around 20 per cent while the Reserve Bank’s cash rate had plummeted. The gap between the two widened from around 7 per cent to more than 15.

The banks justified their rapacious conduct by saying that the price of risk had gone up.

But neither banks fessed up nor did the committee reveal the big sting by the banks – the fact that they really have quite low risk on the vast bulk of their credit card debt.

It works like this. About 60 per cent of households have a mortgage. Even if they have fully paid off their mortgage debt, they usually still have a mortgage. The bank has not encouraged them to register a discharge of mortgage and they usually have not pressed it themselves because the bank will tell them, “You never know when you might need access to money.”

So the mortgage stays registered.

Now, in nearly every mortgage issued by an Australian financial institution you will find amid the fine print a clause which (cutting the legal mumbo jumbo aside) says something like: “This mortgage is good for any debt owed to the bank for any reason whatever and if that debt is not paid we can plonk a For Sale sign outside your home and flog it off unless the debt is repaid.”

That debt, of course, includes your credit-card debt.

So the sort of image the banks want you to have of high risk of flighty 20-somethings running up debts in fashion shops and electronics stores is rubbish.

The fact is that the vast bulk of this credit-card debt is neatly secured in the bricks and mortar of Australian suburbia.

The credit-card rate charged by the major banks to the majority of their customers is unjustified gouging.

Merchants told the committee that they liked credits cards. In the old days, they had to deal with large amounts of cash, inviting robbery. Or they had to extend credit to many customers, resulting in delayed payments and costly debt recovery. To them, the credit-card merchant fee of 1 or 2 per cent is worth it.

But that argument no longer holds. When credit cards were first introduced in the 1970s, there was no internet banking and no debit cards. In those days, the merchants had a point. But these days they can get instant, secure payment without holding vast amounts of cash and without credit cards.

But it’s too late. Everyone has be suckered into credit cards and remained addicted to them because of the rewards system. Earn frequent-flyer points without even flying. Every dollar spent on the card earns you one, 1.5 or even 2 points.

The rewards scheme ends up being more valuable than the airline. With $300 billion put on cards each year with fees of around 1 per cent, you have $3 billion. Take away costs and you have, say, $2 billion a year. A business that earns $2 billion a year is worth, say, $40 billion.

The Senate Committee pointed to anomalies in the system and made some low-grade recommendations to fix them. But in reality we have a monster here – a monster than may replace cash altogether.

The provision of currency is supposed to be a core business of government. But we have handed a large and ever-growing part of it to parasites.

Maybe the Federal Government should issue its own debit card with no fees and no reward points – just like it issues legal tender in the form of bank notes. Merchants, utilities, and governments at all levels would accept that card for free and charge the users of credit cards the full commission they are charged.

All these “free” frequent flyer points would have to be paid for.

And this way we might wean Australian households off some of their corrosive debt.
CRISPIN HULL
This article first appeared in The Canberra Times and other Fairfax Media on 19 December 2015.