A young person recently asked me, "I am not sure if I should get a debit or credit card. What do you think is the right one for me?"
The ideal way of answering a difficult question like this is to say: No debit cards or credit cards for a young person and end there. But then, that’s not practical in this day and age, where we espouse debt as a status symbol and, by saying so, I risk being out of fashion!
As such, it needs a pragmatic answer: Yes, young persons need credit cards or debit cards, but it is necessary to appreciate how these cards work.
EVOLUTION / HISTORY OF CREDIT CARDS
Credit cards are a tool of the money economy. Like all financial services products, credit cards have been tailored to exploit a fundamental human weakness: insecurity. There are three main credit card companies in Singapore: Visa, MasterCard and American Express. Lesser known ones include Diner's Club and JCB.
It is my understanding that credit cards became fashionable at a time when cheques and other equivalent modes of payment were running out of fashion.
Merchants were not getting prompt payment because the cheques would bounce or take time to clear. Consumers did not like to carry wards of cash or the hassle that cheques brought. For example, some merchants started requiring consumers to come and collect the goods after a cheque had cleared. There were also instances when these merchants would even cheat consumers by providing inferior quality goods on the day of collection.
Credit cards dealt with these insecurities because it allowed merchants to collect payment and consumers to collect their goods immediately, at the point of transaction.
DEBIT CARDS VS CREDIT CARDS
The Straits Times recently carried a series of articles on what the young want. Among other things, the newspaper found that the young liked to purchase the latest gadgets and unique travel packages. If you are a young person that likes to buy these things by spending what you have, a debit card is for you. On the other hand, if you are a young person that likes to buy first and pay later, a credit card can be useful.
With a debit card, you spend only what you have. To qualify for a credit, you need - among other things - to earn a minimum income of $30,000 per annum or you need a generous person willing to give you a supplementary card. Most graduates face little difficulty qualifying for a credit card. With a credit card, you get to spend up to twice your monthly salary. Users of credit cards must, however, be disciplined about how they use such cards.
VIEWS OF DEE HOCK (FOUNDER & CEO EMERITUS OF VISA)
In his book, The Birth of the Chaordic Age, Dee Hock, described, among other things, the emergence of Visa as "chaordic". "Chaordic" is a word Dee Hock invented. It means something whose behaviour "harmoniously blends characteristics of both chaos and order".
In my view, credit cards are inherently "chaordic". If it is used properly, it can bring order to a chaotic life. If it is used indiscriminately, it can bring chaos to an orderly lifestyle.
THREE CHAORDIC ATTRIBUTES
There are three features that make credit cards inherently "chaordic":
1. Interest Rates, Late Payment Fee & Annual Fees
2. Minimum Payment & Deadlines
3. Incentives For Spending
INTEREST RATES, LATE PAYMENT FEES & ANNUAL FEES
Interest rates, late payment fees & annual fees are the primary ways in which credit card issuers make their money.
The interest rates that you pay on credit cards are higher than 15% per annum. Interest is charged on the total outstanding amount every month, that is both on what you spend and the current balance on your credit card. This can be painful. As one person describes in the book, Real Tips, Real Money, "It is like paying repeatedly for dinners you have already eaten, trips you have already taken and clothes you have already worn and given aways."
A substantial proportion of people have become bankrupt because they failed to pay up on time. Nevertheless, The Straits Times revealed recently that, due to a healthy economy, the numbers are falling.
If you fail to pay on time, you also incur late payment fees. This is usually charged at a fixed rate of above $20 per month. Citibank recently announced that, in addition to the interest and late payment fee, it would impose an interest rate surcharge of less than 1% if individuals failed to pay on time. The New Paper described this is a first for a bank in Singapore.
Credit card companies also usually charge an annual fee on the card. It is possible to get the issuing banks to waive it, if you spend regularly on your card. More banks are increasingly willing to do so. And, in fact, some banks now use this as a marketing gimmick to get people to apply for their cards.
If you chalk up huge credit card debts, you may also wish to consider refinancing the debt through loans from banks or balance transfer facilities that credit card issuers provides. The advantages of refinancing it through loans are that it disciplines you to pay a regular amount, the interest rates are not variable and eventually you end up getting rid of the debt!
KEY LESSONS ON INTEREST RATES, LATE PAYMENT FEES & ANNUAL FEES
1. It is best not to incur interest and late payment fees.
2. Get the credit card issuer to waive your annual fees.
3. If you have credit card debts, get rid of it quickly.
4. Refinance the debt to enjoy lower interest rates.
MINIMUM PAYMENT & DEADLINES
In order to continue to be able to use a credit card, one is required pay a minimum payment by a certain deadline each month.
The market practice is $100 or 3% of the total outstanding amount, whichever is higher. This minimum payment usually covers the interest and a small percentage of the principal amount owed. At this payment level and if you owe a few thousand dollars, it can take years to fully pay off the debt. It is therefore important to pay more than the minimum sum.
Some credit card issuers are known to change the deadline on which the minimum payments are due. For example, if for one month you need to pay by the 16th day of the month, you may find that in the next month you will need to pay by the 14th day of that month. The strategy is really to get you to incur the late payment fees. Some consider this tactical; others may consider this sneaky.
Fortunately, this is something that not all credit card issuers practice. For example, with Citibank, you can request for the deadline to fall on a certain day of every month. The Consumer Protection (Fair Trading) Act, which will soon apply to financial services products, is also likely to bring an end to such practices.
KEY LESSONS ON MINIMUM PAYMENT & DEADLINES
1. Pay more than the minimum payment.
2. Make sure you check and keep to the payment deadlines.
INCENTIVES FOR SPENDING
Many credit card issuers now try to entice individuals to use their credit cards by providing special discounts at retail outlets, introducing rewards system and organising special events. Some even provide free entry or exclusive offers at popular discos or bars in Singapore. The aim of all these is to entice you to spend and use your credit cards. Often, people end up buying things that they do not really need.
In recent times, some credit card issuers have started providing rebates or cash back, based on what you spend. A good example of this is Standard Chartered Bank's Manhattan Card. I think this is more healthy and less wasteful. It allows users to focus on buying things they need while deriving benefits from spending that is necessary.
The right question the young should ask is not how to choose a credit card. The right question to ask is how to use a credit card properly.
*This article formed the basis of a speech I delivered at National University of Singapore Business School on 30 March 2006.