Did you see this headline last week?
"Over half of Canadians are $200 or less away from not being able to pay bills"
If you're interested in reading the original article, CLICK HERE.
The article was a result of a survey conducted by Ipsos. In addition to finding that most Canadians are within $200 of meeting their financial obligations (a far too thin line), a whopping 31% of respondents do not earn enough to meet their monthly financial obligations and are falling behind each month.
Another shocking finding from the survey was that many respondents didn't understand how a hike in interest rates, by the Bank of Canada, could impact debt repayment, suggesting limited financial literacy.
While I believe that financial literacy is a big contributor to debt cycles, I also believe that financial deceit (or intentful omission) by Canadian lenders is a bigger contributor.
Remember this - no lender is in business to help YOU. They lend money to generate profit - pure and simple.
The point of the following article is to demonstrate deceptive (in my opinion) practices by lenders, so you can keep your eyes peeled and become guarded against 'good deals' offered by your lender. In addition, I'll dig into interest rates so you have a better sense of their complex calculations and why comparing and shopping by only the rate isn't enough to make a good decision.
Low Interest Offers from Banks
I recently received a 'balance transfer' offer from my bank. While I don't have a reason for a balance transfer, I included the letter so you can see it here.
Essentially the offer is to move debt from somewhere else (at a higher rate) onto my credit card at a lower promotional rate of 3.99%.
Their offers looks pretty nice, right?
But then, I kept reading on the second page, in tiny tiny print….
And, it pointed out that if I take advantage of their offer, I would also pay a 1% Promotional Rate Fee. So, if I transfer $1000, I would pay a one-time $10 fee, in addition to the 3.99% interest rate.
And then, it says the promotional rate is in effect until April 30, 2018, at which point the interest rate will increase to the cash advance interest rate (already agreed through my credit card terms and conditions) - which can be upwards of 24.99%.
And, it also says, that if I miss a minimum payment, the promotional rate will end.
And, that if there are any changes to my financial or credit situation, they reserve the right to revoke the promotional rate.
Here's the point - these kinds of offers are BAIT. They are not meant to help you at 3.99%, they are a hook topped with a tasty worm and paired with a prayer that you screw up, miss a payment, or fail to pay the balance transferred before the deadline, and owe the bank - big time.
Even if you've convinced yourself that you'd pay the balance quickly, therefore only taking advantage of the 3.99% offer, the risk (of things not going as you planned) is probably not worth engaging the lender in the first place.
Offers like this make me so angry with the banks. No wonder so many people have financial crises in their lives.
You're right if you feel there isn't enough transparency. You're right if you feel that the fine print is truly so 'fine' it's barely legible.
Even after reading the smallest print on this letter, I'm still left with questions.
Like this one…if I already have $1,000 on the card from another purchase, and then I transfer another $1,000 as part of the promotional offer - so now there's a total of $2,000 sitting on my card. And then, I pay $100 each month - which portion is applied to the original balance versus the balance transferred? In other words, how will they decide how much I've paid off when the deadline looms on April 30, 2018.
Shouldn't banking be clear and upfront?!
In my opinion, financial literacy won't improve anyone's ability to understand the terms and conditions in this type of offer. Only a forensic accountant, or the like, could distil this letter and make sense of it's impact.
In summary, if you receive an offer, or are presented with an offer that looks too good to be true, it probably is just that…too good to be true.
Extrapolating Interest Rates
When you shop for a line of credit, loan or mortgage, what is the predominant determination of your ultimate choice between products?
Likely, the interest rate.
While interest rates themselves are straightforward, what can be worth more of your attention is the frequency of compounding. To make this simple, compounding is how many times the interest is added to the amount you'd borrowed, and then recalculated.
As an example, your line of credit may have an interest rate of 7%.
This is simple to understand, for every $100 borrowed, $7 would be paid in interest.
What matters more though, is how often the interest rate is charged and added to the principle. If the interest amount is recalculated daily, you can see how quickly this original borrowing of $100 can balloon out of control.
Day 2 - $107
Day 3 - 114.49
Day 4 - 112.50
Day 5 - $131.08
Day 6 - $140.26
Day 7 - $150.07
With daily compounding, an additional $50.07 is added to the original $100 borrowed.
In many cases, a line of credit and credit card would be calculated at an 'annual' rate with the interest charged monthly.
In order to be able to identify the likely interest charged on any product, use the following method in the example below:
As an example, a credit card has an interest rate of 19.99% compounded annually. Let's imagine, you carry a $1,000 balance.
To calculate for yourself, you'd multiply the balance of the credit card ($1,000) and multiply it by the interest rate (19.99%) which results in the interest amount for an entire year = $199.90.
To get the amount you'd be charged monthly by the credit card provider, you divide the annual rate by 12 to giving you a rough monthly interest charge, $16.66. Keeping in mind that some months have 28 days, others 30, and some 31.
I've included the screenshot below from my credit card so you can read the 'fine print' so many of us overlook. In the case of my credit card, missing the minimum payment one month, and not paying it before the next statement is prepared will result in an interest rate hike. Rather than 19.99%, my balance becomes subject to 24.99% (for purchases) and 26.99% (for cash advances).
To compare a 24.99% interest rate to our previous example, we crunch the numbers again. $1000 borrowed * 24.99% = $249.90 per year. Divide $249.90 by 12 to get the monthly payment = $20.82.
So rather that $16.66 paid at 19.99% interest, I'd pay $20.82 at 24.99%.
Interest-Free Grace Period
In regards to your credit card, you may (and should) receive an interest-free grace period. I believe this requirement (of credit card providers) stemming from the last financial collapse in 2008 - although I couldn't find any literature to back this up.
Here is a screenshot of the interest-free grace period provided through my credit card lender.
Regardless, your credit card will offer a 21-day interest-free grace period as part of your terms and conditions. What seems slightly misleading to me is that in the event you don't pay the full balance by the statement due date, the interest is still calculated from the date of the transaction, not from the day following the interest-free grace period - the 22nd day. Essentially, the grace period applies with a caveat - pay in full or you'll still be charged interest just the same.
I hope you can see that shopping solely interest rates can be limiting. It is important to understand how often the interest is compounded, how the interest rate offered to you can change based on the way you use borrowed money, and that 'good offers' frequently have too much fine print to make them good.