In this month's Financial Foundations Building Blocks article, I will address a justification many people give concerning their credit card use especially those who have abused credit in the past, or who find themselves in serious debt now. This belief system is costing the people as much as 15% of their take home pay. Here it is let's take a look:
But, I pay my credit cards off every month,
so I am using the credit card company.
Oh yeah, I hear this one about a million times a year. You may be one of the 22% of credit card users who actually do this but chances are you are among the 78% who say they are going to pay it off every month, but then life happens, and the debt starts to accumulate. Just FYI, the Federal Reserve says the average credit card debt per family in this country is $11,000.00. That's just credit card debt. The average American family has $66,000.00 in unsecured debt such as car loans and school loans. That's not counting the house, that's just consumer debt. It's at an all time high, and has reached epidemic proportions.
You see, the credit card companies spend millions of dollars per year studying the financial and behavioral habits of Joe Normal. Trust me these are some smart folks we are dealing with. And they work in some very tall, shiny buildings the rent for which does not come out of their pockets. It comes out of their cardholders' pockets! Don't think for one second that everything they do, and everything they offer you, does not come from a carefully calculated plan to get your money. There is nothing wrong with companies making money, but the way the credit card companies do it is dubious at best.
Most people say that they use credit cards for convenience that is a totally valid point. I use my debit card for convenience as well. I even use a credit card occasionally to reserve a hotel room, or make a reservation of some sort. However, when it comes time to actually pay for the product or service, I pay with cash or my debit card.
What gets most of us in trouble is when we use credit cards as a pad to catch any expenses that we didn't quite have budgeted this month. Little by little it adds up and before we know it, we have racked up thousands of dollars in credit card debt. This was the credit card company's plan all along. In fact, they encourage you to use them to track your expenses more effectively, etc. They know that statistically, you will be carrying a revolving balance soon. Remember, it happens 78% of the time. This is not a game.
We are conditioned to use depreciating debt as a part of our everyday finances. It is almost unheard of these days to pay for everything we have with cash (or debit card). That's exactly what we should be doing however. The only thing we should ever finance is an asset that appreciates, or goes up in value. An example would be real estate. As I said in an earlier article, wealthy people earn interest - poor people pay interest. A few examples of people paying interest might be buying things on credit cards or financing things like cars, clothes, furniture, a boat, etc.
I am not saying that you are a bad person if you use credit cards. Some people actually do use them wisely. I can tell you however, that in my years of financial counseling experience, I have found that credit cards usually end up getting folks into trouble because they do not use them properly.
Another important note I would like to point out is that there have been multiple studies done on the behavior of people who pay off their cards every month. Interesting what the studies say. I'll use a specific report by Dunn and Bradstreet as an example. The researchers found that those of us who use credit cards vs. paying with money that we have in the bank, spend on average 15% more. The reason? Laying down cash money hurts a lot more than swiping a credit card!
Don't believe me? Try it for a month and see if you do not become a more judicious spender. I can tell you from experience that I pay much closer attention to what I spend when I use cash, or my debit card. Finally, let's address the 'Airline Miles' thing. While this may sound good, let me tell you the credit card company does not make any offer on which they are going to lose money. That's not the way businesses work.
The credit card company has ZERO interest in doing something nice for you just because they care about you and your ability to travel. Don't think you are tricking them, or getting a free ride. There is no such thing. Why not save the 15% you statistically spend by using the credit card in the first place, and buy your own airline ticket on Priceline or Travelocity? You come out much better.
Let's say you spend a total of $20,000.00 annually on purchases made on the credit card groceries, eating out, entertainment, etc. You pay the amount off every month. This means that you may get anywhere from 20,000 miles to 100,000 miles in a year. Whoopee!!! Let's say a domestic flight (assuming you can get one with all the black-out dates) is worth 25,000 miles. That's four flights a year assuming you have 100,000 miles accumulated. The flight might cost $500.00 if you bought it outright. $500.00 x 4 flights = $2,000.00. I am being very liberal here because you can get flights for much cheaper.
Assume you started paying with cash or debit card for the $20,000.00 worth of stuff you bought, instead of putting it on the credit card. $20,000.00 x 15% = $3,000.00. You just saved yourself $1,000.00 per year. Airline mile incentives are nothing more than a calculated gamble by the credit card company that you will eventually start to accumulate debt. That was their plan all along. Now you are paying interest which you need not be paying.
In conclusion, if we want to become wealthy, we must emulate the behavior of wealthy people. We should model people who have already demonstrated financial success, and change our behavior accordingly so that we can produce the same outcome. Wealthy people do not finance things that go down in value like cars, clothes, and things you can buy on credit cards. They have all these things, but they pay for them outright. Perhaps we could make a change in our financial behavior that would allow us more financial freedom in the future.
Thanks for reading. |