We have all heard that credit cards are bad but why is that? What is so bad about them and what do we do about it?
I have done some calculations to show how bad credit cards can be – they certainly show how the cc can seriously impact your wealth over time. First things first though, I want first to talk about the concept of a credit card and how that concept itself leads us into financial trouble. The concept of the credit card is to make you think you can afford something NOW that you cannot – let’s have a look!
If you had 10 100 bills in your wallet – would you pull out a credit card to buy something? The answer is, you likely would not – it would be hard to ignore the fact that you already have $1,000 sitting right there that you have already earned that you could use. If we always had that $1,000 in the wallet it would be simple…but… sadly we don’t have that, and the thing we want to buy is right there – it is so nice and guess what – we can easily reach for the credit card and buy it – there is no immediate impact. We have the $1,000 item and our bank account is still the same – no change at all.
Two weeks later – you are enjoying your new $1,000 thing that you really needed and guess what – still no impact on your bank account – life goes on with no problems at all….at the end of the month we get a statement from the credit card company! You now owe $1,000 to the cc company! Well what do we do now? Well we look at the payment required – clearly you don’t have $1,000 to pay the company but it gets easy again – the minimum payment is only $15 – wow, fantastic! That will give me time to come up with the money soon – tax return is due and I am getting $800 back.
A month later – credit card company sends the bill again – basically $1,000 plus the interest of $12 less the $15 payment – you now owe $997 and the tax return is due any day. On the way to work you hit a pothole and blow a tire – tires are worn out anyway so you go to the garage and there is a sale on tires. The tires are $700 but the wheel is bent and you now need an alignment – $700 plus $350 for the wheel and $180 for the alignment – $1,230 and there is no room in the budget for that so now you owe $2,227! The $800 is still on its way though so it won’t take long to fix this.
One month later the tax return is back and it was only $500 instead of $800 and the statement from the cc company is looking for $32 as the minimum payment. You pay the $500 on the statement instead of the $32 and feel pretty good.
It is now April and it has been a tough winter – work has been stressful and your friends have found a deal on an amazing trip. $2,200 for a week at an amazing 5 star all inclusive. The price is usually $4,000 so the deal is too good to pass up – I mean really – a savings of $1,800!! So now your statement comes in and it is $3,927 plus the interest of $27 for $3,954. Minimum payment of $44 for the month and this is a tough month – finding the $44 is tough – your car insurance is due and property taxes are due. You make the $44 payment but put the insurance on the cc for $700 for the year. This is not a problem since you can pay the $700 over 6 months at $140 a month plus the $44 or $188 a month.
In June the trip is amazing – there were so many fun things to do and you spent another $1,500 on the trip for shopping, excursions and a few nights out on the town in Cancun.
You cc bill is now $5,500 in a period of 5 months – by Christmas is it $10,000 with a payment of $300 a month that you cannot afford. You can make the payment but there is no room left to pay the amount any faster than the minimum payment – now the trouble of a credit card sets in.
Let’s talk about the situation that you are now in. You owe $10,000 at a 20% interest rate and although you can make the minimum payment you don’t have the money to pay the amount down any faster so you are pretty well stuck with a monthly interest cost of $166.
Sadly, this is not a story that is all that unusual – it actually happens all the time. People end up with a $10,000 credit card bill and I have done a calculation for you to show you the impact on your wealth. Carrying the 10,000 balance for a period of 30 years (again not that uncommon), the $166 interest payment if invested at 10% interest over that time will cost you $377,000. SCARY!
My point with this discussion to impress on you the ease of getting into the initial debt and how much that will cost you over a period of time.
The real risk of a credit card is wanting things that you cannot afford NOW. A credit card does not make it so you can afford it NOW. A credit card takes money from the future to buy something that you cannot afford NOW – don’t make that mistake and 30 years from now when you have your $400,000 you will thank me!