Blog

All the latest news, facts and tips from the team at Pioneer Credit Connect

16
Jul 18

How to Prevent a Debt Hangover

by Lachlan Hayes
How-to: Prevent a Debt Hangover

Think back to the last big purchase you made with your credit card. Maybe it was a new TV, maybe it was a new set of golf clubs, or maybe it was a new piece of jewelry. Whatever it was, think about the excitement that was building up in you before you purchased that item, and how it felt like you were waiting forever. As creatures of want, when we buy something, we’ll usually expect that happy feeling to last forever. Why? Because we’ve been conditioned to believe we can have what we want, when we want. All too often, that feeling will fade, leaving us wanting something more, now.

I can tell you that almost everyone I know has experienced this in some capacity. The challenge of breaking the loop comes from the frustration experienced when the novelty of that rush wears off and something that once brought you joy, no longer does. And what are you left with? Weeks or months of small repayments on your credit card to remind you that what you bought may no longer have significant meaning in your life. The typical strategy is to chase the high. That unrivalled good feeling, like when someone likes your Instagram photo, gives you a compliment or when you find a carpark right next to the shopping centre entrance. So you hunt to find the next cool item to purchase, creating a sort of debt hangover feedback loop, visualized below.

Debt Hangover Cycle

The above graph is showing us how the purchases and repayments we make can affect our mood. Notice how our happiness increases when we purchase something but then will start to decrease again, further below our original point of happiness, when we still have to pay it off.

In Australia today there are around 16.5 million credit cards in circulation and together we spend over $25 billion a month! There’s no doubt that credit cards are useful. They provide the peace of mind that we will be able to cover day to day expenses, even when an unforeseen event, like a car accident or large utility bill, means that money is tight. How often though, do we find ourselves using our credit cards to purchase those big ticket items that we want but can’t afford? Can we be smarter with how we use our credit cards? How can we reduce the infamous debt hangover?

Big ticket purchases:

The first tip may seem obvious but it is often overlooked. Set up a savings goal! The reality is though, we usually won’t gift ourselves the luxury of saving. So, if credit is the answer you arrive at, try something different. With large purchases, such as a holiday, what other sources of funding are available to replace the boring old credit card?

First, let’s debunk the argument of convenience. Paying for a spur of the moment holiday with a credit card is quick and easy, yes. All you need to do is type a few numbers into some boxes on a website to pay, and bam, you’ve got your tickets. But, like everything technology, businesses are working hard to make transactions quicker and easier. Accessing credit is no different. There are loads of credit products available, like personal loans, which allow you to apply and receive funds within a couple of days.

If disposable cash is available, then put as much of it towards your big purchase as you can to save on paying interest. If you can be patient, then set some savings goals so that you can pay for the whole item outright. If you do have to borrow, based on credit cards on the market today, of which many are listed here, more often than not, you’ll find that you can access credit for big purchases at a lower interest rate with a value-based personal loan.

So how much does the convenience of making big ticket purchases with a credit card actually cost us?

Consider a family holiday to Bali that costs $5000, all expenses covered, staying at a beautiful villa with a breakfast cooked daily and affordable, luxurious days down on the beach. By funding the holiday with a personal loan rather than a credit card, you could save over $1,000 and 6 months of repayments! Shocking right!? Here’s how:

Thanks to something called compound interest, which I encourage you to read about, a higher interest rate can slow down your ability to pay off a debt two-fold. Compound interest is sometimes referred to as “interest on interest” and is often calculated in weekly or monthly periods. In the example below, which is compounded weekly, interest accrues faster on the credit card, because;

  1. The higher interest makes it harder to pay off the principal (the original amount borrowed), meaning,
  2. Less principal is being paid off, so more interest accrues on the balance.
Credit Card vs Personal Loan

Part of the convenience of the credit card is that most of us already have one, but we would have to go out and apply for a personal loan. If this is the case for you, fear not, applications can be done easily online, and will usually be worth the 20-30 minutes effort required to submit the application. Tell me the last time you saved $1000 for 20 minutes work!

You’ll even be able to save more money with a personal loan because, unlike a credit card, you won’t be able to continue spending it when you start paying it back. This means that you’ll actually pay the balance off, rather than getting stuck with an ever increasing balance on your credit card. Although credit still plays a role, this alone will help break the debt hangover feedback loop sooner.

Beware the rewards:

Credit cards sometimes come with a rewards program that will give the users points when they spend money, such as frequent flyers.  This is to encourage you to purchase everything with their credit card, even when, in many instances, you may end up needing to spend beyond your means to access the rewards.

Make sure you fully understand the pros and cons of using your credit card for everyday purchases or you may end up spending much more than you get back in rewards. For items that you can afford outright, use your savings so that you don’t end up paying more than you have to. There is a lot of information online that can help to demystify credit card rewards cards. Completing just a few simple Google searches will produce a few learning opportunities, so start exploring!

5 steps to prevent the debt hangover:

So how can we manage our debt hangovers and our money better?

  1. When we see something that we might want to purchase, we can do some research and find out if there is a similar product that is cheaper or even better suited to you. Avoid the trap of impulse buying and ultra-convenience.
  2. Do the same for rates. We now know that we can probably find a better rate, and save money, with a personal loan instead of a credit card. But, we can save even more by finding even better rates, comparing personal loans with other personal loans.
  3. Put your savings towards your purchases so that you don’t have to borrow as much, saving you interest and repayments.
  4. Make sure you understand the pros and cons of credit cards with rewards and make sure you can actually take advantage of the rewards before you commit to one.
  5. Try to limit your credit card spending to emergencies.