Wanjiku spots a SALE sign in one of the home accessories shops. Being the last week of the month, she is not exactly liquid but “It can’t hurt just to look” she lies to herself. Half an hour later she comes out with a big store bag and Kes 10,000 poorer. As she walked through the shop she remembered she had that secret weapon in her wallet i.e. the Credit Card. She promised herself she would clear the card once she got paid. However, when she gets her bill at the end of the month, she will not pay Kes 10,000; she will pay the minimum charge on it. One of the reasons it is so easy to resort to credit card use is because the amount you owe is stretched into repayments of many small amounts so you never quite feel the pinch of the purchase you make……..or so you think.
Let’s take a closer look at how the maths behind the scenes works. As I was researching on this topic I spoke to a credit card manager in a bank. At his bank credit cards are attracting interest rates of 4% per month. Their minimum repayment is 5% of the amount outstanding. These are the two most important factors to note in your credit card. In Wanjiku’s case she has spent Kes 10,000. The minimum repayment she would be obligated to pay would be Kes 500 (5% of Kes 10,000). However she would also be charged interest of Kes 400 (4% of Kes 10,000). Her outstanding balance would first remove the minimum charge she has made and then add back the interest. Her outstanding balance after the first month would be Kes 10,000 – Kes 500 + Kes 400 = Kes 9,900. It is calculated as; Outstanding Balance less Repayment plus Interest. So despite paying Kes 500, because of the interest charges she has only reduced her balance by 100. The next month the bank will repeat this same calculation based on Kes 9,900. Her minimum charge will be 5% of Kes 9,900 = Kes 495 and the interest of 4% of Kes 9,900 = Kes 396 will be added back making her outstanding balance Kes 9,801. As you can see this method of repayment will take really long. It’s like continually taking three steps forward and then two steps backwards. What the bank is also effectively doing is adding back the interest, and making you pay interest on interest. They are earning compound interest but at your expense. It really is a good business model but not for you. If you’ve been wondering why you have been paying your credit card forever and the balance doesn’t decrease, this is the reason. If Wanjiku continues just making minimum payments she will unknowingly spend about Kes 39,000 shillings in interest for just this one purchase over time but will not realise it because the repayments are so small.
Let’s also say Wanjiku spends an extra Kes 3,000 per month on other purchases and continues making only the minimum payments on her outstanding balance. She would never finish paying this card off! I got tired of calculating after 50 years and she had paid total interest of over Kes 6 million. Remember as long as you are allowing interest to compound and keep being added back you will take an extremely long time to pay it off and it will be very expensive for you. Alternatively if she had from the very beginning just decided to pay Kes 3,000 over and above the minimum repayment (without additional purchases) she actually would have cleared this credit card balance in four months with just a total interest payment of Kes 476. The use of credit cards has become common and I dare say rampant across the world. Just like with anything else there is good use of credit cards and there is bad use of credit cards. Here are a few other tips to remember when it comes to use of this plastic:
- Embrace the concept of delayed gratification. You don’t have to get that item today. As you can see by using a credit card that item can cost you 3-4 times more than you are paying for it. Use cash or a debit card for your purchases. Credit cards may relieve you from feeling the immediate pinch but it is not worth it. If you don’t want to feel the pain of the purchase right now then it is not really worth it. If you have an impulse spending problem do not carry your credit card around.
- If you have to use a credit card pay it back in the interest free days you are given. Most cards give you an interest free period of 30- 45 days. Pay for any purchases back within that period.
- Don’t look at your credit card balance from the aspect of what limit is available for you to spend. Most people forget to look at what they owe and instead focus on spending what is available. Out of all the debts you may have this is probably the most expensive. Put extra money you have into completely paying this off.
- Do not withdraw cash using your credit card. It is very expensive and interest is charged on it immediately. There are no interest free days with cash withdrawals. Depending on the provider cash interest rate can be anywhere from 3.5% to 6%.
- Look at and review your credit card statement every month. Ensure you agree with the transaction costs, purchases and payments reflected. Banks have been known to make mistakes. Make sure you know when your payments are due and pay on time. Late payment charges are simply added on to your balance and you are charged interest on that as well.
Waceke Nduati
The author runs a program on personal financial management. Find her at waceke@centonomy.com or on twitter @centonomy.
Question and Answer
Your article on the cost of a coffee cup really resonated with me. I am salaried and I actually drink coffee every day. How can I practically start ensuring I put this money aside to work for me? John, Kisumu
Calculate the amount you spend on coffee in a given period say a month. In the article I used Kes 200 a day X 30 days is Kes 6,000. Since you are salaried a monthly amount will make sense. When you get paid put the Kes 6,000 in a separate account/ investment scheme immediately. Do not wait for the Kes 6,000 to be there at the end of the month! This will also make sure you stop drinking the coffee because the funds from the get go will not be available for that.
I read your article on personal finance and ways of securing your financial future. Currently I have a job that earns me 10k. I feel I am not saving enough and want to find a way of saving more without having to get a second job but I do not know how to go about it. Please Advice. Dorcas, Nairobi
The definition of madness is doing the same thing and expecting a different result. If you want to save more something has to change. You can choose to reduce your expenses so go through what you are spending every month and see if there are areas to cut down. If not you definitely have to plan to increase your income. Ask yourself – If you want to earn more at your current job what do you have to do? Do you have a skill/hobby that over the weekend or evenings can earn you extra money? If you are serious about saving and have the opportunity to take a second part time job you should do it.
Waceke Nduati
Email your questions or comments to Waceke her at waceke@centonomy.com| twitter @centonomy