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Credit, Credit Cards and Debt, oh my!

Date: Mon Jan 04 2021 ; Tags: Personal Finance »»»» Credit

Looked at another way, is there a positive use for credit cards? Can they be used well in your life? Or must they be shunned? What about large purchases like cars or houses?

Reviewing basic principles

Let's first review the basic principles.

Money is your life force in the material world, and your actions can diminish or amplify that life force

The paths: the way of debt, or the way of amplied life force, they are your choice

available cash = income - necessary expenses

The freedom you have in this world is directly related to the available cash in your life. For better or worse, this is how our commercialized society has shaped itself. It's all governed by that available cash equation.

When it comes to debt and the use of credit cards, the payment of the debt must be added to the necessary expenses. Yes? Why is that? Think for a moment what the credit card company does if you refuse to pay your bill. Eventually they send the modern equivalent of Luigi to break your knees, or in this case it's a collection agency who is going to come after you like a ravenous dog until you pay your debt. But before they send the collection agency after you there is a series of fees for late payments, jacking up of interest rates, etc. Additionally all this goes onto your credit history, which later affects your ability to take more credit. And, further, one must consider the moral side in that you made whatever purchase it is that is on the credit card, making it your obligation to pay the debt. This is why I say payment of debt must be added to the "necessary expenses".

How much is that? This picture may help a little:

Consider buying a laptop computer for $2000 at 18% interest on a credit card. Further, let's assume your credit card has a minimum payment of $100 per month and you elect to pay the minimum.

Month Beginning Balance Finance Charge Payment Ending Balance Decrease per month
1 $2000 $30 $100 $1930 $70
2 $1930 $28.95 $100 $1858.95 $71.05
3 $1858.95 $27.88 $100 $1786.84 $72.11
4 $1786.84 $26.80 $100 $1713.64 $73.20
5 $1713.64 $25.70 $100 $1639.34 $74.30
6 $1639.34 $24.59 $100 $1563.93 $75.41
7 $1563.93 $23.46 $100 $1487.39 $76.54
... $1487.39 ... ... ... ...

Clearly this story is going to go on for awhile. Say you made a "great purchase" and the laptop was $100 off the list price, how many months of interest payment is that? In any case these numbers demonstrate what's shown in the picture above. In your working life how many minutes or hours must you work in order to earn the amount you're paying in interest? If your job is minimum wage, isn't it 5 hours of work to earn the $30 paid in the first months interest? This is the "life force" I'm talking about.

This applies at the national level, not just personal level. In the March 2004 California Primary election they had a bond measure to provide money to rebuild and improve the schools. The direct cost was predicted to be $12 billion, so they desired to float a bond measure to pay for the costs. The bonds would be paid back over a thirty year period at an expected interest rate of 5.5%. The total cost? Add on another $12 billion for the interest. Yes, $12 billion in direct cost ends up costing $24 billion over the life of the bond measure.

That's just one bond measure in one state. As of this writing (March 2004) the total U.S. debt is $7,065,724,603,168.71 (over $7trillion) and the yearly interest payment is hovering between $300-350 billion. Amortize the interest to every person in the country, and that's around $1500 per year per person. Since not every person in the country is also a taxpayer, well, the interest paid per taxpayer is obviously a lot higher, but I don't have the resources available to calculate this. I'm guessing that between $5-10,000 of my tax payments every year goes into just paying these interest payments.

Clearly debt and credit use or abuse is an issue to solve at all levels of our society.

Sane use of credit

At the beginning of this page I questioned "is there a positive use for credit cards"? So far the discussion has been only about the dangers of credit and credit cards. In many resources, such as the Motley Fool Credit and Credit Cards message board the typical sentiment seems to be the shunning of credit wherever possible. Is there a positive use for credit, one that makes sense?

The choice really is up to you. None of what you find on this web site is set in stone, as it is merely my opinion. You, of course, must take these ideas, see if you like them, see how they fit in your life, and if you so choose then figure out how to apply them for yourself. Speaking for myself, I rarely pay with cash, frequently with credit, and I'm fine with that. I'm able to keep my spending at a level where I can pay it off every month, and I endeavor with all my financial skill to do so.

On the other hand many people are unable to control their spending. Buying stuff is more of an addiction for these people. In this case having and using a credit card may seem to be a ticket to infinite amounts of money, and would be an active danger to their lives. If this describes you, then your best route may be to shun the cards.

Here's a few ideas to add to the ferment in your mind.

  • Pay the bill in full every month: If you do like I do, you'll pay the bill every month. You get the convenience of credit cards, but so long as you pay before the due date then you don't owe any interest. By not owing any interest it's the same as if you had paid with cash, and specifically you're not going to lose any "life force".
  • Play games with 0% introductory credit rates: It seems that the only criteria credit card companies use to qualify someone to have a card is to check that they're breathing. If your credit is good the offers flooding in will give you a 0% interest rate for some period of time. It's tempting to see that, use the 0% to buy something big, and you don't have to pay any interest until the deadline. BE CAREFUL for dragons loom in these parts. The credit card companies carefully rig these plans so that if you make the slightest mistake the interest rate will fall on you like a ton of bricks. Read everything carefully before you agree to the plan, and then FOLLOW THROUGH with every requirement. Usually the requirement is simply to make the minimum payment every month, and pay the balance off before the deadline. Maybe there's more, though.
  • Emergency situations: It was a dark and stormy night. You're driving down the road, and suddenly the sound of a gunshot rings out and your car is swerving all over the road. You've had a blowout, you're far from home, you have no cash, and the towing company won't accept a personal check. What will you do? Well, if you've got a credit card that's probably the best choice. There are other situations such as being out of work, your savings dwindling, and the credit card right there. While it's best to have a sizable emergency fund set aside in cash, you don't always have this luxury especially when the expense must be paid right away.
  • Renting cars, airplane flights, hotels, etc: Many types of businesses get real hinky if you pay by any means other than credit card. For example car rental agencies want the extra assurance coming from knowing you have a credit card, and that they have your card number.
  • Cards that pay rewards: Some cards give rewards (such as airline miles, free gasoline, or gift certificates) for every amount spent through the card. Usually these cards have a membership fee. If you want to really make good use of these cards, you should understand the value of the reward, how quickly you earn the reward, and how much spending is required to earn enough through the reward to pay for the membership fee.
  • Huge purchases like cars, boats, airplanes, or houses: It's hard to expect one to save the money to pay for a house with cash. Really. Plus it's not even clear whether you would end up paying less for the house due to the investment income you receive while saving, because you're also having to pay rent while saving for the house. If you're making a purchase where you have to use credit, shop around for the best interest rate and other aspects of the deal. My last car purchase involved a loan at 4.9%, a really decent interest rate.