Wednesday, November 17, 2010

Credit cards can be your friend if used wisely...

Have you noticed the banks pushing out their debit card products more and more of late? Well they say "cashflow is king" and with the credit becoming increasingly difficult and more expensive to come by it's no wonder the banks are encouraging customers to use debit rather than credit.

That is, since you're using your "own money" to purchase goods and/or services rather than "borrowing" the banks money the banks will have more money to lend, and consequently do not need to borrow as much from the international credit market (as while deposits from individuals and businesses do account for money banks lend out, in Australia they also need to borrow money from overseas as well).

The keyword here is "borrowing". Whenever we do use our credit cards we are borrowing their (the banks) money for the hopefully (if you choose your credit card plan appropriately) period of 55 days interest free. If you think about it, you get to use and borrow up to whatever your credit limit is pay the bank back 55 days later. So while you are "borrowing" the banks money to pay for goods and/or services today you can also be earning interest on the money you would have otherwise already given up if you used your "own money" via your debit card and/or cash.

For example, say I spent ("borrowed") $1000 on my credit card for a new TV. Then I have 55 days to pay back the $1000 to the bank, but in the time, my $1000 sitting in my high interest saving account is earning interest on that $1000 earning say if 5% p.a. interest rate a little over $5 for the 55 days.

In contrast, if I'd my "own money" used cash or a debit card then I would not be able to earn the interest ($5 in this example) that I would have earned from a 55 day interest free credit period.

While the benefits aren't terribly enormous in this example, over a period of time it does all adds up. Enough to make banks change their strategy and focus on promoting debit cards rather than credit cards. In business, "cashflow" truly is the king, since you always need to remain solvent (cashflow positive) to continue operating and this means that paying back lenders and bills in time to avoid late fees, interest, remain solvent etc. is important.

What's important to keep in mind that taking advantage of credit cards does require strong discipline and self-control so this is probably not for everyone. As there is potential to spend beyond your means and borrow more from tomorrow to pay for today. This strategy puts you in "temporary" debt so you must stay within your own bounds and know your limits and not extend your normal spending habits. Please consider this carefully and seek further financial advice as required.

So if you use your credit cards "wisely", they can actually be your friend...

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