Wednesday, June 2, 2010

Extreme Common Sense and Consumer Credit

Are you buying on credit because you don’t have the money with you, or because you don’t have the money yet? If the first, consider taking the time to get the cash before you by something nonessential – it will give you time to think instead of react on impulse. If the second, your financial future may be at risk. Credit cards can be an amazing convenience or a horrible trap. It depends on how you use them.

Imagine yourself as the owner of an upscale coffee shop watching your customers. One by one, they come in, order coffee, and pay for it with credit cards. It is the same transaction, over and over, and your business depends on exactly that. On the other side of the counter, each customer comes with a unique story. Let’s guess at a few.

You see Jane once a month. She comes in once a month, buys her drink, then sits at a table to pay her bills while drinking it. Jane doesn’t have the money with her, but she has the money in the bank. The debt will be paid when it is due. She is still buying something she doesn’t strictly need, but her credit is under control.

Bill is one of your regulars. He stops by every morning for coffee and a pastry on his way into the office. Bill pays his card when due, so his credit is under control too. From a financial point of view, his $5 per day would better serve him as $200 a month going into an investment program – he could fully fund an IRA with it. Using cash to make discretionary purchases might make him think twice.

Then there’s Sam – thank God for Sam. He’ll be back later for lunch, and he’ll use plastic then too. Sam doesn’t have the money yet, but payday is next week. He expects to have the money to pay off the card by the time it’s due, and he will if things go according to plan. Sam sits down at his table and plays with his new IPad – the one he expects to pay off in a few months. If he does, all he’s done is add cost to his purchases. If not, life is about to get expensive.

So what are the lessons here?

·         Treat luxuries as luxuries, not as entitlements. Credit can be a useful convenience, a bad habit, or a dangerous addiction. Ask yourself if five years from now you’ll wish you’d made the purchase or not.

·         If you’re buying something you don’t need, wait until you have the money to pay for it. You can reinforce this if you stop by the bank and get cash to pay for that high ticket item. The extra inconvenience and seeing the money being spent may slow you down. If not, enjoy your purchase – you’ve earned it.

·         Even if you choose to use a credit card, wait to buy until you have the money to pay the debt off immediately. Credit is a convenience only when you aren’t paying for it.

·         If you use credit to tide you over, pay it back aggressively. You can count on the tide going out again soon – your creditors do.


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