Monday, July 23, 2012

A Credit Card is a Debt Instrument

A Credit Card is a Debt Instrument.  Simple concept - it eludes many, if not most.

When you apply for a Credit Card, you are applying for a loan.  You are going into debt.  That is plain and simple enough.

Yet, many people don't get this - or refuse to get this.

"I pay the balance every month!" they cry.

Yes, so far that is the case.  But the Credit Card industry knows you better than you know yourself.  And they know that, sooner or later, you will join the legions of "average Americans" who have $15,000 of household credit card debt.

Yes, read it again, that is the average that 55% of credit card holders carry as a balance.

A Credit Card is a debt instrument. 

What does this mean?  What do I mean by this?

Well, to begin with, when you sign up for that $10,000 limit "miles card" at 15% interest, your credit score is dinged by that amount.  Even if you "pay off the balance every month", the people who know a lot more about debt and finance that you ever will realize that this is a potential debt on your account, and will decrease your available borrowing power accordingly.

Your credit score will decrease and the amount you qualify to borrow will decrease, with each additional credit card you get.  And yet, many people see having numerous credit cards as a sign of "good credit".  It is not.

So, whether you "pay off the balance every month" or not, it shows up as a debt, or potential debt, on your record.   If you get a lot of high-limit credit cards, it means you might not be able to borrow money for a mortgage, when you really need it.

A Credit Card is a Debt Instrument, period.

Again, look at the agreement.  It is a loan document - with a balance, an interest rate, and repayment terms.   Only unlike a regular loan, the payment terms can go on indefinitely.  Yes, that is the beauty of "revolving interest" - for the lender, that is.

"But I pay off the balance every month!" you cry.

Good for you.  So far.

No one sets out to end up in intractable Credit Card debt.  And no, the folks who end up over the barrel, being gang-raped by VISA and MASTERCARD were not "weak" or "stupid" - they were merely Average Americans with their $15,000 intractable credit card debt.

And you think, for some reason, you can outsmart the smartest banks, the smartest bankers, the smartest psychologists - in the whole wide world - and "pay off the balance every month" and get free airfare to Duluth.

Good luck with that.  Why do I say this?  Again, the Average American with Credit Card Debt has about $15,000 in household credit card debt.  They didn't get there voluntarily - or willingly.

Approximately 74.9 percent of the U.S. families surveyed in 2004 had credit cards, and 58 percent of those families carried a balance. In 2001, 76.2 percent of families had credit cards, and 55 percent of those families carried a balance. (Source: Federal Reserve Bulletin, February 2006)

Ouch.  What does this mean?  It means that you are very likely to get a credit card, unless you are dirt poor or in jail.  And it means if you get a credit card, the odds are you are going to "carry a balance" and that balance will be significant.

But what about the 45% who don't carry a balance?  They haven't been screwed - just yet.  Wait for it.

So, how do you avoid the credit card trap?  (And it is a trap!).


1.  Do without Credit Cards, if you can.   Yes, this is hard to do in our society, yet 25% of us manage to do so.

2.  Limit the number of cards you have - ONE or ZERO are good numbers.  There is no reason to have three or four or six.

3.  Limit your balance limit:  I chose $5000 for my card, and I told them not to automatically raise it.  This requires that you call them and make this election.   The advantage of a low limit is that you can realistically pay it off.  If you find yourself reaching that limit, then you need to take action - spend less or cash in savings or do something other than racking up more and more debt.

4.  Get a Low Interest Card:  If your interest rate is 7.15%, you have a realistic chance of paying off the card, over time, if you run up a balance (and you will).  At higher rates, like 15% or 25%, you run the risk of never paying off the card - frequent flyer miles or not.

5.  Set up AutoPay:  The "default" or "penalty" rates of 25-30% kick in, if you do not make a payment on time.  If you set up Auto-Pay for the minimum monthly payment, you never need worry about this nightmare scenario - which can occur if you forget to pay a bill on time (and this does happen to even the best of us!).

But the main thing is, to realize that the Credit Card Companies are not your pals, handing out free airline miles or bonus dollars because they like you.  No, they are hoping you will slip and fall and run up $15,000 of intractable credit card debt at such a high interest rate that you will never pay it off - ever, ever, ever.

That is the constant risk you are taking with Credit Cards - slip up once and you are financially destitute for LIFE.

You have been warned.  Now you have no excuse when the inevitable happens.