Are You Paying Interest on Your Pants

The first time we get credit, or make a credit card purchase, it’s a great experience. We feel at last like part of an elite club of card holders. This is because plastic is a status symbol, and you can see it everywhere you go. Credit card adverts always show happy people joyously using their cards to have the good things in life. However, what those advertisements don’t show is the downward financial spiral the interest schemes trick many people into.

Take the example of a pair of pants. You might spend £100 on a designer pair of jeans, and then get that discounted by perhaps 10%, so you’ll think you’re paying £90 for them. When you get the credit card bill, but are tight on cash, you’ll make a minimum payment on that amount. Worse, you’ll probably still use your card for other purchases throughout the month, offsetting any payments you make.

In doing so, your balance will remain at or above the £90 mark that your discounted jeans cost. Because most cards carry an APR of 15% or more, over the course of the year, your total interest on that purchase will be about £13.50. That’s £3.50 more than the jeans cost at full price, and completely erases the savings you thought you got. In other words, you didn’t actually get to pocket the savings you thought you had by picking up a pair of jeans on sale.

Of course, at the end of the year, you’re not likely to be thinking about this, or even considering the original purchase of your jeans that triggered the interest spiral. That’s because no one has taught you how, or more importantly why to do that. Considering the damage credit cards do on a regular basis, it’s a bit surprising that Parliament has’t done more to educate people about these dangers. After all, you can’t get a permit to operate an auto without a license, which requires training and certification, and you can’t you can’t teach without the proper certificates.

Yet, you can completely destroy your financial life, and contribute to the decline of the economy in the UK, with just one credit card. All it takes is having a job, and a bank account. Then, that one card can slowly eat away your savings, siphoning away money you could have put into your pension, and draining funds you might have used to purchase a home. All because you purchased your jeans with a credit card. Sounds crazy doesn’t it? Unfortunately though, it’s anything but crazy. In fact, it’s why High Street sits so high. It’s built on countless donations from uneducated consumers trying to meet the social standard set by having a credit card, but it doesn’t have to be that way.

Think About Your Purchases

The next time you want to purchase a pair of jeans, or anything for that matter, use cash. Assuming you’d put the £10 you saved on that initial jeans purchase, and calculating the dozens of other purchases you’ll make over the course of a year, you could be saving hundreds of pounds. Tucked away in a relatively conservative investment account, that money could be earning you £10, £20, or even £30 a year in interest.

Do that for five years, and you’ll be earning enough interest every year to buy all the jeans you want, without needing to spend any of the money you’re earning during the week. High street won’t like it though, so you may end up needing to keep at least one credit card to have a record of your credit history with the credit reference agencies. That does not mean you need to pay interest though. Quite the opposite.

Get a no-fee credit card from Santander, HSBC, or another bank you’re comfortable doing business with. Then, open a linked interest bearing savings or current account with £500. We’ll call this your interest savings account. Next, set up the primary account, where you keep your money or get paid, to automatically transfer £200 a week into your interest savings account. Then, set up your credit card account to always automatically pay the full balance each month from your interest savings account. Make sure to keep track of your purchases, and pay attention to your online balances in the interest savings account so you don’t get any overdraft fees or unpleasant surprises.

This way you’ll be building credit, paying no interest on your purchases, and keeping a steady cycle of funds going into your interest savings account. When that account exceeds the total balance of your credit card (or about £2,500), you can start putting the extra money into a pension, investment account, or any account that’s ahead of inflation.

As an added bonus, you can even get a cash back credit card that will pay you for purchases. Even if it’s just 1% per year, that’s an extra 1% you can set aside. By doing this, your jeans will pay for themselves over time, and you’ll be able to put the interest and accrued savings in your pocket, instead of on High Street.

Paul graduated in 2001 with a degree in Finance. Since then he has gone on to work for several of the UK's most well-known financial institutions.

An avid blogger and a huge football fan, Paul is here to guide you through the ins and outs of personal finance and perhaps save you some money in the process!

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