Beware traps of a low-rate credit card

If you don't pay off your credit card bills off every month, a low-rate, no annual fee card may sound tempting.

According to the Canadian Bankers Association, 44 per cent of Canadian credit card holders carry a balance, making low-rate cards -- such as the American Express Essential credit card, which offers 8.99 per cent interest on purchases and 1.99 per cent on balance transfers -- especially enticing.

But these cards don't always work out as well as they seem at first glance. Sometimes they can be a trap for borrowers who don't have control of their finances and spending. low-rate-traps

Before you run out and apply for any low-rate credit card, here's a quick user's guide -- pros and cons -- to these credit cards:

The savings are great -- if you follow the rules
The average Canadian credit card comes with about a 20 per cent interest rate on purchases; store credit cards average around 28 per cent interest. So if you can transfer a balance to a low-rate credit card, or start using one with lower interest for purchases or emergencies, the savings can be considerable.

However, you need to read the fine print.

For instance, the American Express Essential's low 1.99 per cent interest on balance transfers is only available at the time of application and only applies up to $7,500 transferred or 50 per cent of your credit limit, whichever is lower.

Furthermore, even if you do secure Essential's low balance transfer rate at the time of application, the introductory rate lasts just six months. After that, the interest rate rises to the regular rate of 8.99 per cent. Some balance transfers also come with transfer fees.

Even without the introductory deal though, the 8.99 per cent rate still offers substantial savings. As an example, using a balance of $5,000, the approximate monthly interest was calculated with the Financial Consumer Agency of Canada (FCAC) credit card interest calculator.

Interest rate comparison
Interest rate
 Approx. monthly interest
28%
$116.67
20%
$83.33
8.99%
$37.46
1.99%
$8.29

If you carry credit card debt only for the short-term, such as when you use your credit card strictly for emergencies, you can realize significant savings with a low interest card.

"That's where it's a good idea to have a low interest card," says Norah Foster, certified credit counsellor, K3C Credit Counselling in Ottawa. "But then make a plan to pay that off. Don't put anything else on that credit card and get it paid off."

The importance of properly managed accounts
If you have a larger credit card balance that you'll carry longer term, you can save even more. This is why when properly managed, transferring a balance to a no or lower interest rate card can be a good way to maximize your savings, says Jared Webb, financial adviser at Fernhill Financial in Victoria.

The key phrase, however, is properly managed. Reducing your interest should only be part of your plan, says Foster.

"The other part is making sure you can pay that off," Foster says. "If you don't have a plan and you don't have good payment habits and you miss a payment, your interest rate could go higher than what you paid with your previous card."

Most credit cards have a clause in the fine print that if you miss a payment or if a payment is late, your interest rate will be increased, often for several months.

For example, the American Express Essential card's fine print states that if you fail to make a payment for two or more consecutive billing periods or if you miss any three payments, your interest rate will increase to 26.99 per cent -- quite a bit more than the average rate on most Canadian credit cards.

"No one looks at whether they can afford an item," Webb says. "They look at if they can afford the payments."

Ask yourself: If you can no longer afford to make the minimum payment at 8.99 per cent, how will you afford it at triple the interest?

More cards, more to juggle
If your credit card balance is more than the maximum allowable for transfer, you will still owe money on your higher rate card. You'll have two credit card payments to keep up with, and you'll need to pay both on time, and preferably more than the minimum amount.

"Can you really afford to make both payments from a budgeting point of view?" says Foster.

In addition, if you keep both cards (your current card and a new low-interest card) and don't change your excessive spending habits, "you're going to find yourself deep in debt," says Foster. "You haven't fixed the problem at all."

You're simply moving the problem from one card to another, she says, and if you can't contain your spending, you'll end up using your high-interest card anyway.

What you need to do is deal with your spending problem, if that's the case, or take a look at your budget and see why you can't get by without relying on credit, she says.

Get in control of your finances
Instead of looking at whether you can afford a credit card payment, think about whether you can afford the items you're buying.

"If you focus on the payments [rather than the balance], you'll never get out of debt," says Webb. "You get sucked into the debt vortex."

To get out, "you have to have a budget," Foster says. "We have to have a plan for a sustainable lifestyle."

"You need to ensure that what goes in is higher than what goes out," Webb says. "Period."

"What goes out" needs to include the total cost of the item you're charging on your card, not just the monthly payment.

"The low interest card is, for most people, a trap because they haven't got a plan," says Foster. "You have to deal with the problem first." Then you can make the lower interest rate work for you.

See related: How credit card interest works, Store credit cards: the good, the bad and the ugly, Poll: Interest rate the top reason for credit card breakups
Published October 7, 2016

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