Credit Conundrum…
Ladies and gentlemen! Allow me to introduce the next highly controversial topic: the credit card. This shiny little piece of plastic and mystery is the source of so much joy and sorrow within our country, and to be quite frank, the ethics involved are pretty questionable. I’m going to give you a highly summarized version of what exactly is going on here, buckle up.
Most of you probably understand what a credit card is as well as what it does. Basically, instead of spending the money that’s in your bank account (what a debit card is used for), you spend the credit card company’s money, and pay it back at the end of the month. That’s right, it’s debt. If you use the card enough, the company will reward you with airline tickets, money back, etc. However, if you fail to pay back the full amount borrowed at the end of the month, the company hits you with a ridiculous interest rate on the unpaid amount. There are basically two schools of thought:
Take advantage of the rewards, build credit, and use the system to your advantage.
Don’t. “Debt is bad” (in a southern accent). Sound familiar?
Here’s the thing. Everyone is confident that they are an exception to the rule. They’re convinced they will pay off their credit card in full every month and play the system to get free flights, hotel stays, etc. Take note: when you don’t see the money exit your account immediately it doesn’t hurt as much, and it’s way easier to spend a lot more. It’s all psychology. Here are some shocking statistics:
The total credit card debt in the United States totals $1.12 trillion (with a “T”), which is about $3,275 per person. That’s the number you get if you divide the total credit card debt by the US population, which means we are assigning debt to 1st graders as well.
The average credit card debt per American household is $7,951 (U.S. Census Bureau).
The average credit card interest rate (APR) is about 20% according to various sources on Google, and that’s rounding down to be safe. This means the average household pays $1,590 to the credit card companies in interest alone every year.
I wanted to start with that. If everyone played the system correctly, those numbers wouldn’t be so bad! There’s a reason why you get all those colorful credit card applications in the mail; the business is massively profitable. Here’s why the ethics of this are so questionable. A credit card company profits when you can’t pay off your balance every month. That means that the business only succeeds when their customers fail to manage their money properly or run into hard times. Additionally, if you earn rewards from a credit card company, your rewards are indirectly paid for with the interest from someone who couldn’t make their payment. It all just smells bad.
However, there’s another way to look at it. The rewards you earn are technically coming out of the credit card company’s pocket, and that I like. It’s kind of like shooting a squirt gun at a campfire. You’re playing with fire and therefore you are at risk of getting burned, but at the same time, you aren’t doing the fire any favors. Be advised: the fire wins that game a lot.
There is another reason to own a credit card, and that is to “build credit”. A good credit score will qualify you for a better mortgage rate, and the process is pretty simple. Keep in mind that it’s possible to get a fantastic mortgage rate without a credit score through a process known as manual underwriting. The catch is that this is a lot more complicated, and requires a very involved financial overview of tax returns, bank statements, rental history, income, assets, debt, liabilities, etc. So, while it is riskier, having a good credit score does make it easier to get a mortgage. It also makes it easier to do random miscellaneous things such as rent a car when you go on vacation. For informational purposes, here is what goes into your credit score, and why the calculation is so mysterious and confusing:
Payment History (35% of the total score): They’re looking for a consistent pattern of paying off credit card balances in full.
Amounts Owed (30%): Owing money isn’t bad, but owing too much is. How much is too much? Your guess is as good as mine.
Credit History (15%): The longer you’ve had an account, the better your score.
New Credit (10%): Opening too many accounts in a short period of time will lower your score. How many is too many? Well, it varies by individual.
Credit Mix (10%): Having different kinds of accounts (credit cards, retail accounts, installment loans, etc.) shows that you faithfully make payments in all areas of life, and therefore qualify for a higher score. Again though, too many is bad.
What’s the bottom line? Be careful. Pay it off or cut it up. Understand it or avoid it. Too many people are prevented from investing properly and building actual wealth because the interest on their credit card debt cuts into their disposable income. That’s how they getcha.
Mad? Skeptical? Want the next post to apply more to your personal situation?
brett@centennialsec.com or use the “Contact” tab above.
