Tuesday, September 1, 2009

Living Beyond Your Means - Credit Card Debt

Having Credit Cards is like trying to keep a pet Velociraptor.  You may think of them as pets, but one day they will tear your guts out and eat you alive. 

You've heard the phrase "Living Beyond Your Means" many times before. We all like to think we are living within our means, but many of us, at one time or another in our lives, do live beyond our means, and oftentimes, this means that we pay the price later on.

When I was younger, I was much more lackadaisical about money. I made "good" money, or so I thought, so I didn't keep track of it. To me, the ultimate luxury was not having to keep track of money.

Every month, I made all my payments, and if there was anything left over, I spent it. And if I ran out of money, there was always the credit card to use.

In the last two decades, Americans have been spending like drunken sailors and "living beyond their means". What does this mean? Let me explain.

In the typical scenario, Joe and Harriet Consumer do as I did - they get a paycheck and spend it - on cars, meals out, cable TV, and of course a mortgage payment. The balance on their credit card doesn't alarm them, because they can always make the payment. And if they are a week or two late, so what? Darn credit card companies can go sit on a tack!

Besides, the credit card company keeps raising their limit, in letters that say "Congratulations! We've increased your credit line!" When one card gets "full" they take advantage of a "rollover
offer to move the debt to another, lower interest card. Unfortunately, they keep the old card and run it up again as well.

But one day, Joe and Harriet discover they have $50,000 in credit card debt, spread out over five or six credit cards. No matter what they do, they can barely make the minimum payments and the balance on these cards never seems to go down.

The local bank has an answer. Joe sees an ad on TeeVee for a home equity loan or a refinance. They take equity out of their home to pay off credit card debt. While this is may be a good short-term solution, in reality, it only aggravates the situation. To begin with, the refinancing includes a lot of fees and expenses (often thousands of dollars worth). Second, Joe and Harriet are spending more money they don't really have. Taking equity out of a home is dipping into savings at best, spending phantom equity at worst. Third, now that Joe and Harriet are "out of debt" they congratulate themselves for their financial acumen and start spending on credit cards again. Within a few years, they are back where they started, only worse.

Having Credit Cards is like having pet Velociraptors around the house. They look so cute when they are young and all, and maybe you've raised them from a egg, when they were just $1000 limit cards you got in College. But one day, they grow up into monsters and tear your abdomen out with their claws and feast on your intestines. Yes, credit cards are really that bad.

So how do you avoid "Living Beyond Your Means?" Well, the first step is to closely monitor credit card debt. Even if you can't watch every expense every month and track it in Quickbooks or Quicken or the like, you should pay careful attention to your Credit Card statements and track them over time.

Simply stated, if your credit card balance is increasing over time, then you are "Living Beyond Your Means. You are borrowing money from tomorrow to live today. That is the simple test.

Now in some very special situations, you may need to use credit cards to tide yourself over during a period of unexpected expenses, such a losing a job or a sudden illness. But even then, you should explore alternate means, as that debt can come back to haunt you.

The problem with incurring credit card debt is that if you are late on even one payment, the card companies can jack your rates to 20-30 percent or more, and you will never pay off the balance, due to the high interest payments. If your credit is not stellar, you will find it difficult to borrow at a lower rate to get out from under these loan-shark like terms. For many, the only alternative is bankruptcy.

The Obama administration has promised to curb the abuses of the credit card industry. Guess what? The credit card industry has more power than the Obama administration. So the proposed legislation is shelved, at least for the time being.

So how do you avoid this deadly trap?

First of all, cut up credit cards and get rid of them. At most, you need ONE card, not five or six. NEVER let them raise your limit as a "favor". Get rid of store cards, too.

Second, pick a limit you are comfortable with and stick with it. If they raise it, call them and ask them to lower it again.

Third, use a debit card for purchases where you ordinarily use a credit card. Buying gas and paying cash is a pain. But a debit card makes it easy. Scare stories about debit cards are spread by the credit card industry, which sees them as a threat to their lucrative interest business. (Credit card companies make 2-5% on each purchase, PLUS the interest you pay, PLUS any fees, it is like a license to print money. No wonder they could care less about fraud!)

Fourth, check your bill every month and make sure that the balance is zero, or at least LESS than the previous month's balance. If you balance is INCREASING, sound the alarm and cut back on some expenses. I suggest dumping cable TeeVee, for starters, as it tends to give you a lot of bad ideas about finances.

Fifth, setup your credit card to auto-pay from your checking account every month, the minimum amount due. This way, you will not be late on a payment, triggering a "default" interest rate.

Sixth, if you are carrying a balance, pay more than the monthly minimum (in additional payments) and make a long term plan to pay it OFF completely and keep it that way. Again, cut some other expenses (see my blog here for ideas) and apply the savings to this debt.

For middle-class Americans, it is possible to "Live Beyond Your Means" for decades, and in their 30's and 40's many people do, oblivious to the overall cost of their lifestyle or their simple inattention to financial matters.  And once you start living beyond your means (borrowing money) the interest charged compounds the problem, so that you have even less and less money to spend.  Pretty soon, you are borrowing more and more and paying most of your income to banks, in the form of interest.

Eventually, however, you will be forced to live within your means. Retirement is a rude awakening for many people, as they realize exactly how much money they squandered over the years, and moreover, how much they will have to cut back in order to survive.

Running out of money before you die is not a pleasant prospect. However, it is the decisions you make NOW, in your 20's, 30's and 40's which determine whether or not this will happen. It rarely is the case that a retiree makes a mistake after retiring that causes them to lose it all.

Put those Velociraptors in a cage - or better yet, just kill them off entirely.