Your Money & You – April 2012

Tackle Your Credit Card Debts

Australians have over $36 billion owing on credit cards where interest is being charged. That's an average of $4,700 debt per card holder. Are you one of these people?

Don't let the compound interest inflate your debt over time. If your credit card debt is slowly building up, now is as good a time as any to confront it head on.

The message is clear: Make paying off your credit card debt a top priority. Pay off as much as you can afford, as quickly as possible.

Avoid compounding interest

Let's say you've got a credit card debt of $4,700. If you only make the minimum repayments, it will take 49 years to pay off your card and that assumes you don't use it anymore. The interest charged over that time would grow to around $14,600. (Assumes 18.5% interest and a minimum repayment of 2%.)

The good news is that with a little discipline you can reduce the debt dramatically. If you pay off $250 each month instead of the minimum repayment, you’ll pay off your debt in two years and save around $13,700 in interest.

By reducing your credit card debt to zero, you'll save around $800 per year in unnecessary interest charges. That's money you could spend on things you really want.

I encourage everyone with credit card debt to go to the MoneySmart credit card calculator and see how much money you can save.

Top tips

If you are serious about tackling your credit card debt, here are the four things you need to do:

1. Pay more than the minimum repayment – even an extra $50 per month will make a big difference.
2. Stop adding more debt to your credit card. That means you stop using the card as much as possible.
3. Set up a direct debit to pay a fixed amount off your credit card balance each payday. That way you won't even notice the money going out.
4. If you have more than one card, pay off the card with the highest interest rate first.

More than one card?

If you've got multiple credit cards, once you pay them off only keep the cheapest one – the one with the lowest interest rate or fees. Be sure to cancel your credit cards properly by informing your bank, because if you just cut it them up and don't tell your bank you may still have to pay fees.

Once you've paid off your credit card, consider only using it for emergencies. Also think about using a debit card instead of a credit card for online purchases so that you’re buying things with money you already have.

To try out the credit card calculator, go to www.moneysmart.gov.au. Send your ideas for articles to ADFcolumn@asic.gov.au.

Greg Medcraft
Chairman
Australian Securities and Investments Commission

Shares or property - which is better?

Australians have been comparing shares and home ownership for many decades.

In reality – thanks for research conducted by AMP – pre-tax rates of return on shares and investment housing have averaged just over 11% per annum over the long term. This average return includes the reinvestment of company dividends and net rental yield for houses.

Over the long term they have both converged around a single number. However in the short term housing and shares are often out of sync.

For example in the late 1980s share prices slumped but property values soared. In the latter half of the 1990s housing prices were flat but shares soared. Since 2007 housing have been remarkably settled but shares have been belted.

Some commentators expect average house prices will be fairly flat over the next few years. Strong population growth, low recent levels of construction and the reasonably strong economy suggest average house prices will adjust back to their long term trend rather than a dramatic drop.

How does the Reserve Bank set interest rates?

On the first Tuesday of every month, except January, the Reserve Bank Board meets. One of its functions is to set the 'cash rate'. Have you ever wondered what this means and how it impacts the economy?

The Reserve Bank of Australia is responsible for formulating and implementing monetary policy.

The Reserve Bank board meetings set the interest rate on overnight loans in the money market – this is the 'cash rate'.

The RBA's website explains that "from day to day, the Bank’s Domestic Markets Department has the task of maintaining conditions in the money market so as to keep the cash rate at or near an operating target decided by the [RBA] Board." It does this by managing the supply of funds available to banks in the money market.

"The cash rate is the rate charged on overnight loans between financial intermediaries. It has a powerful influence on other interest rates and forms the base on which the structure of interest rates in the economy is built. ... Changes in monetary policy mean a change in the operating target for the cash rate, and hence a shift in the interest rate structure prevailing in the financial system," said the RBA on its website.

When setting interest rates the Reserve Bank board must take into account three legislative requirements:

• the stability of the currency of Australia;
• the maintenance of full employment in Australia; and
• the economic prosperity and welfare of the people of Australia.

Since 1993, these objectives have found practical expression in a target for consumer price inflation, of 2–3 per cent per annum over the medium term.

Controlling inflation preserves the value of money which helps form a sound basis for long-term growth in the economy.