Overdraft Death Spiral
Overdrafts are in essence a line of credit available for businesses. Similar to a credit card the customer pays interest for the amount that they’ve drawn down plus an ongoing fee for access to the funds. Like a credit card , access to the funds is simple and people often fall into the trap where they continually owe money to the bank. For example you may have an overdraft of $50k and for most of the year that overdraft balance will sit between $40k and $50k. What people don’t understand is that this behaviour affects their credit record and increases the borrowing cost on this facility.
For example when applying for a business loan of any sort there is a standard process that you will go through which routinely is consistent across all the banks:
The business application (it should be noted that each institution asks the same questions, however a different application is required by each bank). The application includes a number of standard questions and should include a business case, a statement of position (flows of money in and out) and a balance sheet that covers what you’re worth
Once the application is received the bank will run the application through a workflow process that will auto generate typically 3 results
Auto approved (usually lower amounts with complete information)
Refer it out for reasons such as : large amount required, incomplete information or it’s a line ball decision
Auto declined where the numbers simply don’t stack up or the information provided isn’t sufficient
The bank will then complete a risk assessment of the deal which will dictate the pricing offered and whether the larger deferred deals are approved or not. In essence the risk assessment is a number which reflects the riskiness of the client/ deal (usually between 1 and 10 – 1 being the best and 10 the worst and a letter that reflects security (i.e. what you are offering to secure the loan/ i.e. collateral) This is usually A to F, A being fully secured (that is if you were to go bankrupt, that the bank would be guaranteed to get their funds repaid in full and F being that no security is being offered/ or potentially something like a guarantee form yourself/ parents etc., however banks are unlikely to use this (poor publicity) so not worth anything to them.
The level of risk is determined by factors such as your credit record . So things such as your age, the industry that you work, your credit record, your age, your track record, the assets and liabilities that you have, your spending patterns, your experience etc.
In relation to security the more you are will to put in the more comfortable the banks are to lending you money. Someone that is rated A would typically have funds invested in a term deposit / or something similar that matched the amount being lent. You may ask why borrow if you have the funds, the typical answer is that with the help of a good accountant business costs and personal costs are treated differently.
So once the banks assesses your risk and security rating that will determine what they charge you for the funds lent. The lower the number and the letter the cheaper the interest charges will be on your loan. It is important to note that the bank will perform an annual review of your loans and this risk and security assessment will updated and this will determine the costs of borrowing for the next year. Therefore if you have paid everything on time and as expected then the interest you are charged may go down. Likewise if you are constantly late, have an overdraft that is constantly at or near your line of credit limit then that will make the bank nervous and interest costs may go up.
Interest is the cost of capital and is determined by a number of factors including the overnight borrowing rate, the RBA cash rate, the cost of overseas funds, the rate they need to attract depositors etc. This in turn determines a base rate that a premium is added; the premium added is determined by the risk and security rating. So for example if the base rate is 5% (business rate is normally higher than the personal rate as there are larger amounts involved and a riskier proposition for the bank) then depending on your risk rating an additional amount will be added on top of this rate of 5%, so the better your rating then the lower that amount is.
Over time if there are worrying trends with your business, then as soon as your risk rating gets into the 7 to 8 range (i.e. constantly overdrawing, late payments, no cash flow, risky market or business, key person leaves, fraud occurs etc.), then the bank will classify you in the high risk category. What this means is that the interest cost will increase (you are now a riskier proposition) and that you will be more regularly observed (annual review may turn into a quarterly review) and the bank will actively assist you to get back under the 7 risk area.
If you transition into the 9 plus range, then the bank will actively manage you out of their care. This may mean that they will put in place an action plan to right the ship, that they may involve a liquidator or external managers to oversee your business or that they may move you out of their bank into external specialists. Either way banks will try and trade you back into a position where the business once again becomes viable rather than close shop.
(Article 4) Death of the credit card industry?
The credit card industry used to be a $50b industry. That is until providers such as such as Afterpay, Zip, Openpay, Humm, Payright and Klarna who allow you to spread the cost of a purchase over time without having to pay interest entered the market.
For those that are still on credit cards there are a few things that you should note:
Make Debt a priority
Don’t just replay the minimum
Research how long it will take you to repay the debt and make sure this is achievable
Don’t chase rewards (e.g.. frequent flyer) – mozo $19,000 average spend get $27 on average back (some cards fees > the reward)
Use Credit only when necessary – cards can charge 20% +, why not get a loan? Cards charge for the convenience at a premium
Credit Cards
Australians have over $50 billion worth of funds on credit cards, with over 60% of all these funds accruing debt, many at excessive rates as high as 20%.
Competition and increased consumer interest in credit has seen the banks seemingly innovate and outdo each other in offering less and less interest or less and less fees, all in the guise of benefiting the consumer.
Behind these flashy low-interest or no fee credit cards lies a number of hidden charges and traps Australian consumers are falling for time and time again, even leading the Australian Securities and Investment Commission to launch an investigation the practices.
The fundamental of managing your debt is quite simple, pay off those your facilities/ loans with the highest rates first, keep as little in cash as you can and shorten outstanding loans wherever you can. Companies such as mybudget simply put this concept into play by reorganising your outstanding debts by:
Converting multiple credit cards charging 20% plus interest onto one person loan or adding it to your mortgage. This consolidates your debt, reduces your rate significantly and provides a goal to target.
Cash typically doesn’t earn any interest and normally you can utilise an offset facility as debit card so you have ready cash available if required.
Credit cards/ overdrafts have no fixed end date so as long as you have it you’ll be paying interest. Debt accrues interest so the longer you take to pay it off the more you are going to pay, that is your outstanding balance continue to grow as capital and interest continues to incur further interest.
The most common incentives and offers:
Zero Interest Periods and Zero Fees for Balance Transfers
Credit Cards today are being advertised as zero interest or zero fee under certain conditions. But what does this really mean?
Due to the rise in competition in the lucrative credit card market, card companies are offering zero interest periods on their cards in order to lure in new customers. However, in order to recoup the lost return from these zero interest periods, the interest rate charged after that period often skyrockets to astronomical numbers. ASIC has noted that this practice has ‘taken advantage’ of many consumers who have been enticed by the initial interest free period and cannot afford the higher interest periods that follow.
‘The banks know who these deals appeal to, and people who are struggling with debt are quite profitable customers.’
Consumer Action Law Centre's Katherine Temple
Zero balance transfer fees are an offer used to promote the switching from one card provider to another, but in practice, it is often used to transfer or consolidate debt from one card to another. These credit cards usually counteract their zero-balance transfer deal by charging higher rates of interest or by surprising you with hidden fees or rises in the future. The combination of these two innovations in the credit card industry means that those who accrue debt within the zero-interest period often simply change cards to another card offering another zero-interest period. The debt however does not disappear, rather it snowballs and eventually must be repaid.
Reward and Loyalty Points offers:
Earn money for your next Holiday while spending money on the things you need, what could be better!
The reality is a lot less glamorous. For starters, these cards often charge far higher fees than traditional low fee credit cards, spruiking the idea that earning reward points necessitate these fees. However, in many cases, as leading Australian consumer information website Mozo affirms, the fees charged by these cards are often larger than the rewards points amount earned. The website found that 45 of the leading credit cards on the market in Australia resulted in higher fees charged than the dollar amount of Rewards points earned.
Further, the Rewards Points earned have been reduced significantly over the past few years and look likely to continue, with a 63% reduction by the large credit card providers occurring in the last 12 months alone.
As the Mozo research concludes, the average spend on a credit card in a given year is $19,000. Spending this much on your purchases on an average reward card would only result in $27 worth of rewards points earned in a year.
Therefore, we find a Reward or Loyalty card can in some circumstances be beneficial, but often the lure of rewards points can be less attractive and lead to higher fees upon further investigation.
Additionally the value of these points continues to diminish. Depending on the program many of these programs offer very little in return for dollars spent. In many cases for each dollar spent the value of points equates to less than a cent.
In terms of utilising your points how many times have you gone to book a flight and you thought that surely I’ve accumulated enough points to discount your flight. In reality if you can find a flight available using your points you’ll quite often find the following:
That the points accumulated make very little difference. That is the cost is roughly the same as if you go directly to one of the discounted fare sites (i.e. skyscanner, webjet etc.)
That to utilise your free flight that you need to book at least 6 to 8 weeks prior to your flight and if you don’t use then the flight is lost for good. There is no room for flexibility with this and quite often as I found out, I tried to organise a free flight and I was 5 weeks and 4 days in advance and they weren’t able to accommodate me my request as they needed 6 weeks.
Most often when you use points, it’s only for 1 ticket or maybe two, what happens if you want to book the rest of your family. Well it is easiest to organise in the one booking, so using their travel booking site/ agent the additional seats are typically more expensive and if you were to organise independently then it is difficult to consolidate the booking. In the end it becomes too hard and so either you don’t use your points or you end up paying more just for the convenience of not having to consolidate everything.
Many points programs have an expiry date or get devalued at some point.
Points are complicated to understand and everyone has their tricks, so if you’d like to know more then look to sites such as points hacks to understand the deals that are on offer.
So how do we avoid getting stung with high rates and fees?
Make Debt a Priority
Repay more than the minimum required or completely if possible
Research how long it will take to repay debt and plan
Don’t chase rewards
Don’t chase zero interest deals
Use Credit only when necessary (and remember you eventually have to pay it back)