Credit cards that incur interest are incredibly expensive. Any situation where a client is paying interest on a credit card must be addressed in a thorough SOA.
The average interest rate payable on credit cards is over 17% per annum. As this interest is typically not tax-deductible, this equates to an effective pre-tax interest rate of almost 27% for a person earning more than $80,000 per year. What this means, of course, is that paying down interest-bearing credit card debt will earn such clients a guaranteed 27% return per year. Not even Warren Buffett in one if his best years can beat that type of return.
Managing credit card debt typically takes a little more strategy than managing a home loan. This is because a person with credit card debt is unlikely to have any spare cash available to pay down the debt. But this does not mean that nothing can be done. Typical moves to reduce or eliminate credit card debt can include:
- Consolidating credit card debts by redrawing on a home loan;
- Taking a personal loan to pay out the credit card/s;
- Using an interest free period on credit card transfers – and then working feverishly to eliminate the debt during the interest-free period (after which the credit card issuer starts to charge an even higher interest rate);
- Where there is more than one credit card: targeting the card with the highest interest rate applicable to be repaid first;
- Negotiating with the credit card provider; or
- Selling something and using the proceeds to pay down debt.
As you can see, at least some of these moves require real behavioural change on the part of your client. It may be hard to motivate your client to change, but it is still good to try. For example, you might try some paragraphs like the following:
I know its outside the scope of my advice, and you did not consult me specifically on this issue, but for completeness I suggest you consider re-drawing $20,000 from your home loan and using it to pay off your credit card debt.
This will save you about $3,400 a year in non-deductible interest on the credit card. At current home loan rates, the extra debt will only cost you around $1,000 in additional interest income. So, you save $2,400 every year. In your 37% tax bracket this is the same as earning about $3,800 in pre-tax income. In other words, this simple steps is the same as increasing your salary by almost $4,000 per year.
And, for completeness, once you have done this: get rid of your credit cards!
As we say, clients with credit card debt might resist your suggestions for change. Their liking for credit is what got them into debt in the first place. But you should at least address the issue as a way of demonstrating that your SOA is a thorough and client-centred document.
You can read more about this and other strategies here: Dover’s non-deductible debt management materials. Please take the time to read these materials as even a small goal kicked for a client with regards to debt management expands out to large gains as things compound over time. Most advisers find that the strategies here more than pay for themselves over time.