Wednesday, October 21, 2015

How Credit Cards Erode Your Life

To a young person, having a lot of credit cards means you are financially successful.   When they get into financial trouble, their blinders prevent them from seeing that credit cards are actually the problem.

On reddit the other day, was this plea from a young woman who couldn't figure out where all the money was going.   But if you read her detailed scenario, one thing jumps right out at you.   She has an awful lot of credit cards and other loan debts, for a young person:

Long story short. I am a 25 year old female who is continually struggling with money and debt even though I now work two jobs, both above minimum wage, and I can’t really figure out why. Looking for some tough love and harsh truths, right down to people telling me exactly what to do here.
Below I have outlined my debts as well as my bills, and my estimated earnings for both jobs. Both are hourly so they can vary depending on clock in/clock out times, but rarely by much. Neither have opportunity for overtime. Both are new jobs, Job 1 I’ve been at since the middle of September and Job 2 since about two weeks after that. Before that I was laid off for 2.5 months which is where the spiral into money issues really took its toll. It’s no excuse, I should have been better. I know better. Though I will say that 2/3 of the AMEX debt was a very expensive dental surgery I needed that couldn’t be avoided.
I currently have less than $200 cash to my name. No savings re-built yet from when I depleted it during my layoff.
Job 1: 40 hours/week @ $15.50/hr = $944 biweekly after tax
Job 2: 18 hours/week @ $8.25/hr = $232 biweekly after tax
Total: $1176 biweekly, ish.

$$ Debt
$11,000 Student Loans
5,831 Auto Loan
3,970 American Express Blue Cash Preferred Credit Card †
1,219 Huntington National Bank Voice Credit Card
999 Barclaycard Sallie Mae Credit Card †
960 Personal Loan
973 Credit Union “Flex” Credit Line **
$24,952 Total
† These cards have no interest until April
** This has no interest at all

$$ Bills
$230 Car Insurance
190 Car Loan Payment
160 Healthcare and Dental
100 Treasury Collections†
100 Personal Loan Payment
65 Student Loan Minimum Payment
50 Huntington CC Payment‡
50 AMEX CC Payment‡
50 Barclaycard CC Payment‡
40 Electric Bill
36 Internet Bill
30 FlexLine Payment Minimum
26 Frivolous Monthly Things
20 Gym Membership

(The first thing you notice about this scenario is how everything is chopped up into weekly, bi-weekly, and monthly numbers, making it hard to parse.   According to her numbers, she is making $39,962 a year in gross income (not bad) and taking home $30,576, or $2548 a month.  Her expenses are $1147, leaving $1401 in disposable income!)

If you look at her situation, she does not have a staggering amount of student loan debt (whose interest is deductible, and is a long-term investment, hopefully, if she got a worthwhile degree).   Even the auto loan debt is pretty small, although having a car loan when young is problematic, as it means paying exorbitant insurance rates.  $230 a month for car insurance is more than what I pay a year for basic liability, or at about for 6-9 month's coverage if I want collision.   How much you wanna bet she has a low deductible, with towing and rental car coverage, as well as uninsured motorists and medical?  Again, this is typical among young people - they take the quote offered by the friendly local agent and don't question it.  I would suggest GEICO, online, where you can see what coverage you are paying for, and how much each aspect costs.

But the real deal is three credit cards, a "personal loan" and a "flex credit line".   You cannot borrow your way to wealth and debt is anti-wealth.   It seems like a pretty simple proposition, really.  You borrow a dollar, you have to pay back a $1.20 at credit card interest rates.   Perhaps even $2, as the interest is "revolving".   So when you borrow money, you are making yourself poorer, as you now have less money to spend or save every month.

Fortunately, the solution here is pretty simpleCut up the credit cards.   Keep the lowest interest rate card and discard the rest.   And no, miles are rewards don't compensate for the cost of all that interest she is paying.   If you are carrying a balance, even for one month of the year, chances are the interest is wiping out any 1-3% "savings" with a reward card.  They throw pennies at us, hoping we spend dollars.

Similarly, she should pay off the "flex line" and close the account, as well as the "personal loan".   Granted, this may take a few months, but the money she might save by switching to GEICO and dumping junk coverage might help pay for this.  Why close a "flex line" of credit?  Because it is a temptation to borrow, and borrowed money has to be paid back.   The fewer sources of immediate credit you have in your life, the less likely you are to borrow.

Of course, if you read her plea carefully, you realize she has $1401 a month in leftover money - more than half her income.   And she says she pays no rent.  Obviously, there is a $1401 hole in her budget here that she doesn't want to talk about for some reason.   Partying?  Dining out?   Drinks at the club?   Clothing?  What?  The silence is telling.

The bulk of the credit card debt was for an AMEX card for "very expensive dental surgery" she needed.  I certainly hope she got a second opinion on that, as dentists, as I have noted before, often suggest expensive work that is not really needed, and then suggest financing it.  Chain dental stores are the worst at this sort of thing - and yes, they do target the young and naive - particularly young people with dental insurance (as she claims to have).

When you are younger, what a man in a white lab coat says often seems like the word of God himself - particularly when you are lying prone and have a lot of cotton and instruments in your mouth.   Many of us are not trained to be skeptical of doctors and dentists, and it is only when you get older and realize that many of them are just schmucks like you and me - and many of them are quite incompetent as well - that you start to question these things.

Fortunately, this young woman isn't quite in a pickle just yet.  Her debt load is equal to about a 2/3 year's income at this point - after tax (she is taking home 30,576 a year!) and that also means her debt service is less than 1/5 of her income, which is not considered onerous by the banks, at least, who view 1/3 as the stress point.

Note also, the amounts shown for the card payments are clearly the minimum amounts due.  If you make a $50 a month card payment on a $4000 AMEX debt, it will take you forever to pay it off!

She just needs to make different choices and change her mentality.  Stop looking at debt as the answer to all problems.  Stop looking at credit cards as a sign of wealth.   Challenge authorities - the dentist, the insurance agent - and don't take it for granted that you need thousands of dollars in dental surgery or to pay thousands of dollars to insure a $5000 car.

And stop looking at life in terms of monthly income and monthly payments.   Note how her entire financial "picture" is couched in those terms - how much I make a bi-week and how much I have to spend per month.   She is not looking at the overall net worth picture which is understandable, as from what I can see, her current net worth is about -$20,000 (assuming the car is worth five grand).   Net worth is your real financial altimeter - telling you how far about the ground you are.   Until you figure out your net worth - on a monthly basis at least - you really can't tell if you are climbing or spiraling into the ground.

When you borrow a dollar, you make yourself a dollar poorer.   It is as simple as that.   If you find yourself constantly having to borrow money, chances are, you are living beyond your means.   Borrowing more money to continue the scheme just makes no sense at all.

And what is really appalling to me, is that this young lady, at age 25, is making good money.   It is sad that a single person, making that much money, has no savings at all.  Kind of hard to feel sorry for that!

We all make choices in life.   And her situation is one of poor choices, in every sense of the word.  She is not a victim of circumstance in any sense.

* * *

NOTE:  Speaking of normative cues, I am sure this young woman gets "a starbucks" every day and tosses the "barista" a huge tip and thinks nothing of it.  After all, "everyone does it" right?   Everyone else is broke, too.  No one wants to think that "trivial" thinks like fast-food lunches and designer coffees are making them broke, but in truth, they are.