Understanding Credit Cards and Why they Keep you Poor

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As-Salaam Alaykum dear readers,

I wanted to write up something explaining how credit cards work and how they are created to keep you poor. The majority of people living in the west have them, and sometimes they are a necessary evil to be able to buy the goods that we use on a daily basis. Some would argue that cash can still be used in most places, but we are increasingly seeing the removal of cashiers, tills and dispensement of cash; opting to go with technologies such as debit/credit and tap (contactless payment) to purchase.

From a wealth-building perspective, credit cards offer a quick channel to funds; but the compounding interest can be devastating for people unable to pay on time. In America, the average credit card debt per borrower has been rising in recent years to $5,554 in the first quarter of 2019. The same report shows that 37% of Americans have revolving credit card debt from month-to-month. Things aren’t any better in Canada, with the average Canadian owing $8,500 in consumer debt. In the UK, total credit card debt was £72.6 billion in February of 2019, with the average credit card debt at £2,649 per household. With revolving credit debt, it’s a big detractor in keeping you poor and delays your financial independence.

How do I understand credit card rates?

Most people have credit cards, so we need to explore how exactly they work and what makes up your credit card terms that you agree to when when taking a card from a bank / provider. With most cards, a bank works with a specific issuer (VISA / Master Card etc.) to bring a branded product for the traditional banking customer. Typical these cards have some major elements to them:

1. A credit limit – credit limits vary greatly depending on your income, credit score, and existing debt. There is great variability in how a bank approves you for a credit card, with some banks offering you a subprime card (higher interest rates) based on the risk of an individual defaulting on their payments. Some of these factors are:
   • Your credit score
   • Your monthly income (self-reported)
   • Your monthly rent or mortgage payment (self-reported)
   • Your existing credit lines and balances
   • Your employment history
   • Your address history (how long you’ve lived at your address)
2. The interest rate – This is structured in what they call the APR (Annual Percentage Rate). This is the annual rate charged per year as a percentage to the borrower. Most cards are on a variable APR which takes the current prime interest rate and add the banks margin on top to get a percentage.

Let’s take a look at an example

Here is an example of an everyday spending credit card from a major bank in the UK – HSBC.

As you can see there are some important pieces of information about this card:

1. The “assumed” credit limit – This would represent an average credit limit that the bank would look to issue cards at for its customers for this specific product. This credit limit (£1,200) drives the types of interest rates you might see. If your approved credit limit is higher or lower, you might have different interest rates offered by the bank.
2. The interest rate – This is 22.9% APR variable which means that the rate might float higher or lower based on the prime interest rate in the UK.
3. They are offering 0% interest for the first 18 months of using the card, but also charge a 2.9% fee if you choose to consolidate other debt or credit cards to this one in the first 2 months.
4. No annual fees for the card.
5. There is a minimum monthly repayment of 1% of the principle or 2.5% of the balance at the end of the month.

So what’s the big deal? The interest is not that high, right?

Aside from it being forbidden to muslims to both lend and borrow at interest, we can flush out some examples over time to see how much interest compounds if you don’t pay off your card.

Example after the “interest free” period of 18 months:

£3,000 credit balance on a 22.9% interest rate card with minimum monthly payments of 2.5 %

Credit Balance: £3,000

Interest Rate: 22.9%

Minimum Repayment Amount: Starting at a £75 and going down as you pay the card off

Over the course of 35 YEARS to the pay card off at the minimum payment amount, you are looking at £3,000 principle + £6,473 of interest for a total of £9,473 to be paid back. That means that you are paying back 315% of your borrowed amount on minimum payments. That folks, is how interest makes your poor! It only gets worse if you have higher credit limits and higher balances.

I have lots of cards and lots of debt, what do I do?

There are some ways for your to get “out of the hole“, and out of debt faster if you have run up your credit cards and are not making progress against the interest you are paying:

1. Switch to a fixed payment schedule – If you are able, try and dedicate a fixed amount to the outstanding balance of your cards. By maintaining a regular amount, you can significantly reduce your interest.
2. Pay off your highest interest rate cards first – If you have multiple cards, try and pay off the highest cards first, as the longer they run with balances they more you will pay in the long term.
3. Call your credit card company and negotiate – Call your credit card company and try to negotiate the interest rate down if you can. Some banks will allow you to do this if there you are friendly or if you are truly heading towards to bankruptcy.
4. Freeze your cards and reduce expenses – Freezing your cards with the bank will force you to not use them, so you can focus on paying them off. Also, looking for ways to reduce expenses to put more towards your payments is important.
5. Consolidate your cards to a bigger, lower interest loan – There are many services out there where you can consolidate into a loan or line-of-credit and pay off all of your credit cards avoiding the high interest rates. Loans typically have much lower interest rates than credit cards.

Carrying debt can be very stressful to you and your family, so the best advice is to avoid using cards and buying things that you really cannot afford. We as humans make mistakes; but working on rectifying them is critical.

As the Prophet (SAWS) said: In Sahih Muslim – (1598) narrated that Jaabir said: The Messenger of Allah (blessings and peace of Allah be upon him) cursed the one who consumes riba and the one who pays it, the one who writes it down and the two who witness it, and he said: they are all the same. 

We don’t want to forsake the blessing that we receive or recieve Allah’s (SWT) curse upon us; so the best option is to avoid interest or work quickly to get out of of it as soon as possible.

I hope this post on credit card debt was interesting and insightful. As usual, I would love to here any comments, feedbacks or suggestions on new topics on the Muslim Financial Independence Blog or on my twitter @muslimfinancial. See you all soon!

As-Salaam Alaykum