Sunday, December 4, 2011

Examples of Personal Credit Card Crisis

I believe most Americans get into a Credit Card Crisis at one time of their life or another - and that the Credit Card industry counts on this - it makes them a LOT of money!

Credit Cards are the crack cocaine of the finance industry - or perhaps the methamphetamine.   The nature of meth or cocaine is to make you feel invincible, and of course, you feel you have the drug habit "under control".  Why not?  You're as high as a kite!

Credit Cards work the same way.  A person with encroaching credit card debt will never admit to the problem.  Or if they even do, they will say it was a one-time deal and not a symptom of a more chronic condition.  It seems we all live in denial.

As I have noted before, surveys show that 70% of Americans claim to pay off their credit cards every month.  And yet, 70% of Americans carry a balance - according to the Credit Card industry, which has the computer data to back this up.  As Americans, we lie to ourselves - a lot - and this self-deception is the root cause of most of our financial difficulties.

Getting a Credit Card is not hard to do in this country.  Offers are made to family pets and the dead, on a regular basis.  And until fairly recently, college students were targeted for Credit Cards.  As a young adult, starting out with that first good-paying job, you may be pleased to get a letter in the mail saying, "Congratulations!  You have been pre-approved for a new VISA card!"  And you may think to yourself that this is validation of your success as a 25-year-old.

And of  course, at that age, it is all too easy to fall into the first trap they set - that you are "lucky" to get a credit card and that getting one is some sort of privilege - based on the mysterious workings of the almighty Credit Score, a holy number kept by the high priests and priestesses of TransUnion, Exquifax, and Experion.  They get you to buy into the idea that they are calling the shots, and that you are fortunate to have been chosen to be pre-approved for a gold card.

Of course, as you get older, you might switch your allegiances to a rewards card - giving airline miles, hotel stays, or cash back.  And you may start to think you are in control of things - calling the shots - as you are snookering "free" rewards out of those stupid Credit Card companies who are foolish enough to give them to you.

But eventually - and perhaps on more than one occasion, you get in over your head with Credit Cards.  And it isn't hard to do - and many, if not most people do it.  And once in, it is very hard to get out.

1.  Brad was offered a credit card in College.  It was a basic VISA card with a $2000 limit.  Going away to school was a great time for Brad, as he was finally able to do all the things he wanted to do in life - things that his parents said "No" to, or that he couldn't afford.  Drinking beer, smoking pot, staying out all night, having sex - it was like being a real adult for the first time in his life, without all that messy responsibility attached.

Getting the Credit Card was just another rush.  When he went out to a pizza place with his friends, he impressed them by paying with his credit card.  He bought dinner for everyone.  And later on, they went shopping at the mall, where he bought clothes, and a new game station, as well as a host of new CDs and other items.  It was so easy - he just whipped out the credit card and bought what he wanted to, just as he had seen his parents do.

He didn't worry about the payments.  His parents gave him an allowance for college to pay for books and other incidentals.  He figured he could make the monthly payments out of that.  But the first month's bill was a shocker.  He had ran up more than half the credit limit and the monthly payment of $100 was all his disposable income for the month.

So, of course, he used the card to buy books and other necessary supplies, the next month.  Now, of course, interest was kicking in, at the 22.5% rate that didn't seem like such a big deal when he signed the papers at the card table in front of the student center two months earlier.

The next month, things got worse.  The balance kept creeping up toward the limit, and he could barely make the monthly payment.  On the third month, he was late with a payments.  The fourth month, he was over the limit.

The credit card company jacked his rate to the "penalty" rate of 30% and since he was over his limit, he could not charge any more on the card.  It has been only 12 months, now, and he is now in serious trouble.  He was now broke most of the time, as his monthly allowance was barely enough to make the monthly minimum payment.  At this point,  it would take years for him to pay off the card.

In tears, he calls his parents and tells them what happened.  His parents, after much shouting and after many angry words, agree to pay off the card.  The credit card companies have won this first round, collecting hundreds of dollars in interest payments - as well as the 2-5% on each purchase - as well as over-limit and late fees.  They have made a lot of money off of one kid's youthful indiscretion.

And now, of course, Brad's Credit Score is negatively affected, which affects his ability to get loans out of college or even jobs.  Brad is lucky that his parents are wealthy enough to pay off the card.  Others are not as fortunate.  They cannot pay off the card and end up with a ruined Credit Score (showing months and months of unpaid debt) and find that getting a job out of college is far more difficult.  And getting that first apartment, more so.  And getting that first car loan, impossible.

I know more than a few Brads.  I rented apartments to Brad (not his real name) once he married and settled down.  Even though his credit card fiasco was years in the past, his credit score was such that he and his wife found it hard to rent in the trendy hi-rise apartments that his co-workers lived in.  And as much as he and his wife wanted to buy a house, they found they could not qualify for anything other than sub-prime rates.

Ah, sub-prime lending!  How did that happen again?  Yup, people took those crappy mortgages because they couldn't qualify for anything else.  Why couldn't they qualify?  In many, if not most cases, it was because they had screwed up their credit records by getting into credit card debt problems.

2. Tim managed to avoid the college credit card trap.  But as a young divorcee, he had to make child support payments for his three kids.  But at the same time, he liked to hang out with his 20-something friends, going to clubs, buying clothes at the mall and doing all the same things they did, which appeared to him to be normal things people in his group did.

Problem was, he couldn't afford it.  The child support pretty much tapped out his income, and as a parent, he should have been buckling down to pay for raising children, even if his wife has custody.  Instead, he tried to live the life of a single person, dating women, going out to fancy restaurants, and buying lots of trendy clothes.

Each month, the balance on his credit cards climbed steadily.  Very quickly, he started making only the minimum monthly payments on each of his five cards - promising himself that "next month" he would get ahead of the game.  Next month never came.

The minimum monthly payments continued to rise with the balances, and at the high interest rates he had on his cards, he would never pay these debts off, at the minimum monthly rate.  Compounding this, the payments took up much of his disposable income, so he would charge more on the cards to pay for his daily living expenses.  This is how the snowball effect takes off with credit cards.  Once you are on the hook with the card, you don't have any cash left after you make your payments - so you use the card more and more, rather than less and less.  And the only way to pay off these cards is to stop using them.

But since you can't pay off the cards and put food on the table, you use the cards more.  It is a vicious circle, and it ends, often years later, when the card limits are finally reached, the "penalty" interest rates kick in, payments are missed, late payments and over-limit charges are assessed, and the credit card companies and collection agencies start making nasty phone calls.

Finally, Tim calls a bankruptcy lawyer.  The lawyer charges him $500 for a bankruptcy proceeding.  But thanks to new laws on the books, Tim can't get all the debt discharged, but merely have a payment plan worked out, over time.  As a result, the interest might be waived, but the balance is still due - and Tim will spend the next five years paying it off.

The credit card companies win again.  Tim has paid nearly as much as he has charged already, in terms of interest payments, late payment fees, over-limit fees, annual fees, and the like - plus they get the 2-5% on every charge from the merchant.  Now they get the original amount back on top of that - nearly doubling their money.  Sweet deal - for the Credit Card companies.

And now, Tim has a bankruptcy on his credit report, meaning he can't get any sort of loan for several years, and even after that, on onerous terms.  They have him right where they want him.

(Actually, Tim can get loans, even after bankruptcy, but at very high interest rates.  And he can't declare bankruptcy for another seven years, if he defaults on that loan).

3.  Joe is a suburban homeowner who thinks he is pretty sophisticated.   After all he has a high-paying job making close to six figures, a nice house in the suburbs, two new cars in the driveway, and a wallet full of credit cards.  He and his wife Suzie use the credit cards for everything - to buy gas, pay for groceries, and of course to go to dinner several nights a week.

Why not?  For every dollar they spend, they get airline miles!  So they will be able to fly to Florida (or at least one of them will be able to) after they charge $50,000 on the credit card.  The cards have high interest rates of 20% or more, but they don't worry about that - after all, they pay off the balance every month - or nearly every month - so they don't pay interest.  Or much interest, anyway.  What's $100?  You can spend that on Dinner!

The problem comes when a small crisis intervenes in their lives.  They are spending more than they are making and not funding their retirement properly.  While they are making good money, they are spending even more, convinced that since their neighbors have a lot of neat stuff and services, they should, too.  A new cell phone plan, a cable TV plan with all the sports channels, a new flat-screen TV - all paid for on credit cards.

The balances on the cards are creeping up, but don't seem very worrisome.  After all, what is $10,000 on a credit card, when you make $100,000 a year?  But there are several credit cards, and the balances are climbing, ever so slowly.  And the interest charges are increasing as well.

They discover that their home needs a new furnace, and they decide to put that on a credit card, since winter is coming.  $5000 is added to the balance.  Now, it gets really hard to pay this down, and the interest is pretty staggering.

The credit card payments eat up their monthly disposable income, which they compensate for by using the credit cards more.  Pretty soon, they have gone around that knee-curve bend where it becomes impossible to pay back the loan at the 22.5% interest rates.  Joe and Suzie are in a Credit Card Crisis.

But, it is the year 2005, and you can refinance your house and take out money!  And since the interest rates are lower, your effective monthly payment is the same - if not less!  So they do it, and add tens of thousands of dollars to the balance of their mortgage, including several thousand in closing costs and junk fees.  But their credit cards are paid off in full and their monthly mortgage is about the same.

They congratulate themselves on being financial geniuses and go right back to their old habits with renewed vigor.  Why not?  They have been rewarded for poor financial behavior.  They become "serial refinancers" and make light of it.  Why not?  Everyone else in Foreclosure Mews Estates talks about refinancing in the same way, at the cocktail parties they attend.

But of course, we know what happened to Joe and Suzie.  Their apparent wealth evaporated in 2008, when the value of their home collapsed and their 401(k), such as it was, took a hit.  And their newly racked-up credit card debt had no where to go.

* * *

OK, you say, these people are idiots.  Only a fool would do things like live beyond their means.  But it happened to a lot of people, not only during the last recession, but over the years.   It happened to me.   How does it happen?  We've outlined that above.  Why does that happen?  Weakness, poor normative cues, peer pressure.  How you can you avoid it?  Let's look at this one bit at a time.

As for the Why, we also sort of addressed that above.  When it seems "normal" to use credit cards and to buy lots of stuff - like your friends at neighbors are doing - it is easy to get into trouble.

Peer pressure is strong.  Kids in college are mocked if they say they can't afford to keep up with their peers' spending.  Even 20-something kids feel the need to 'fit in' with their friends.  And yes, even 30-50 year-olds will succumb to the pressure of the cul-de-sac and spend themselves into poverty trying to keep up with the Jones next door.

Cute ad, but the answer to crippling debt isn't more debt, it's spending less.  Golf club membership?  Really?

Poor Normative Cues - usually from the television - are also to blame.  During the height of the Real Estate madness, there was an ad on TeeVee from Lending Tree where a man extols the virtues of the suburban upper-middle-class lifestyle.  The tag line is, "I'm in debt up to my eyeballs!  Someone please help me!"  The solution?  A home equity loan, of course, courtesy of Lending Tree!  There, in a nutshell, is the fiscal crisis of 2008, boiled down to a 60-second commercial.

And yet, many of felt that way back then - in debt up to our eyeballs - and wondering what to do.  And many of us used the home equity loan or refinance as a "way out" of our troubles.  A way out, it turns out, that did not solve much.

A lot has changed since then.  A lot, except that human nature is about the same and we are all prone to weakness.  And today, you can't get-out-of-jail-free by taking equity out of your home.  You have to pay up, or declare bankruptcy.  And people still go bankrupt today, over credit card debt.

How can you avoid this problem?  It isn't easy.  But it is a problem worth avoiding, just as it is worthwhile NOT to drive off a cliff.  Here are some steps you can take to avoid the pitfalls of Credit Card debt:

1.  Realize the serious nature of the problem:  A $5000 credit card debt may sound insignificant when compared to your overall wealth or income, but it can creep up, over time, particularly when multiple credit cards are involved and they increase your line of credit.  Take this seriously - that is the first step.

2.  Recognize your weakness:  We are all "at risk" to becoming drug addicts, alcoholics, criminals, or whatever - given the right circumstances.  None of us are Supermen, and if that is your plan on avoiding these sort of compulsive-addictive behaviors (being a Superman) then you are even more likely to fall into the trap.  The human mind is weak, and temptation is strong.  This message should be familiar to you, after all it is the basis of most of the world's basic religions.

3.  Use Credit Cards sparingly:  Debit cards never rack up debt.  You can't spend cash you don't have.  Writing checks is even safer.

4.  Avoid the Rewards:  Frequent flyer miles and cash-back rewards are the BAIT they put in the TRAP.  Which part of TRAP did you not understand?  Only a fool mouse goes for the cheese, when it is baiting a deadly trap.  The same is true for "rewards cards" and their staggeringly high interest rates.

5.  Get as few cards if possible, if any:  A debit card may serve your needs just fine.  You may need a credit card for business, if you have to wait to get reimbursed for expenses or charges.  Or, if you need to rent a car, they can be handy.  Having five or six cards, however, is never a good idea.

6.  Get the lowest RATE possible:  There are cards out there with rates approaching mortgage levels - 6-7% or so.  Get a low-rate card and keep it.  If you do charge up a lot, you at least have a fighting chance of paying it off.

7.  Get the lowest LIMIT that is reasonable:  A limit of more than $5000 is ridiculous.  And yet, credit card companies will give you cards with limits of $10,000, $15,000, $20,000 or more.  At one time, I had $50,000 in available credit on credit cards - enough to buy a really nice car.  That is a LOT OF DEBT to accumulate at 22% interest!  Keep your limit low and CALL THEM and tell them NOT to raise your limit automatically.

Now, a lot of you are thinking, "Well, what about the MOST OBVIOUS thing?  The one that all the TeeVee pundits tell you?  What about PAYING OFF THE BALANCE EVERY MONTH?"

Yea, the financial guru on the TeeVee says that, and it is NOT on my list, for a good reason.  Why?  What did I say at the beginning?  That 70% of all Americans carry a balance!  Telling people to pay off the balance every month is like saying "Avoid paying mortgage interest by paying off your mortgage, dummy!"

Chances are, you don't have that kind of money laying around to pay off your mortgage - am I correct?

And chances are, you don't have that kind of money laying around to pay off your credit cards, if you are carrying a balance.  So telling you to pay it off is like saying "Hey, while you are at it, invent a cure for the common cold, OK?"

Yes, you SHOULD pay off the balance every month.  And the easiest way to do this is to NOT HAVE A BALANCE AT ALL - either by not using the cards or by using them very sparingly.

But chances are, if you are reading this, you have a balance on your credit card, and it is eating away at you like a cancer.  And try as you might, you can't seem to pay it off.  How can you get a fresh start?

Well, that is what this blog is about.  The whole thing, not piecemeal parts of it.  And unfortunately, there are folks who think, "Well, I can cherry-pick some ideas here and there, cafeteria style, while not affecting my lifestyle dramatically.  After all, who can live without Cable TV and Cell Phones?"

And yet, so many people are broke, have under-funded their retirement, are telling themselves (or others) that they will "work until they are 75" or are heavily in credit card debt - while at the same time are paying hundreds of dollars a month in cell phone, cable TV, car payments, car insurance, and a whole host of unnecessary charges and expenses.

I know I was, to the tune of well over $1000 a month or more.  And in the last three years, I have managed to shave that down - and get out of debt.  But the secret was to have no "sacred cows" or "untouchable" areas of my finance.

Everything, is up for grabs.  But that is the subject of my next posting.