Handling Finances

Back in January, I wrote about the hidden cost of using credit cards. Especially for small businesses, the 2% or greater fees merchants pay to credit card companies can be very painful! As customers, we don’t usually see the interchange fees except at the occasional small business where they charge a small fee for credit card transfers to recoup their cost.

Of course, with the credit card companies competing for users, they’re quite willing to give back some portion of this money as a “reward.” While the reward comes out of interchange fees (and thus must be compensated by an increase in prices for merchants to break even), effectively saving 1% on all your expenses can be quite significant! Of course some people see credit cards as evil and cash back as a worthless ruse. I’d suggest that they’re missing the point.

First of all, I don’t know of anybody that has ever “worked themselves up into a froth over getting 1% back from a credit card.”  Right away this particular blogger makes it clear that they’re exaggerating for effect (that or disconnected from reality).  For the sake of an informative article, I’ll ignore this sort of colorful interjection and instead discuss some of the more reasoned complaints about credit card rewards.

The Bible is not anti-credit card!

As a Christian, I’m always quite disturbed to see Christians taking Biblical teaching out of context.  While the author of Proverbs (probably largely King Solomon) had a great point that the borrower is slave to the lender, this was never intended as a blanket condemnation of borrowing or lending.  Taken to the extreme, I have heard that there are people who refuse to take out a mortgage and who will not deposit money in the banks (what do you think they do with that money?).  Heck, even checks are small loans — you promise to pay later (through your bank) for goods or services acquired today.  I don’t think this particular blogger is quite that extreme, but their suggestion that you have to “sell your soul to the credit card companies” — followed by a Biblical quote rather carelessly insinuates that credit cards are Biblically evil.  Again, I’ll move on and leave that bit of unsupported hyperbole alone.

Credit cards would still be profitable if nobody carried a balance.

This particular blogger then hints at the truth before falling into another rant about commercials encouraging spending:

Yes, it is possible to use credit cards responsibly and I’ve actually seen it done. But lenders don’t make money off of responsible usage. Or not as much off of responsible usage - there is the ever-present transaction fee as well as the occasional annual fee. They make more money off of spending more and spending more often.

I’d say the 20% of 109 billion annual profit they make off interchange fees is pretty significant.  And yes, while it’s true that credit card companies target people who will carry a balance and pay interest, this is yet again not remotely a reason for responsible users to avoid credit cards.  Not only do they greatly simplify accounting (it takes as long to download all the transactions in a month as it would to manually enter a single cash transaction) but they allow a greater flexibility in payment.  Because of credit cards, I am able to keep a much larger portion of my cash in interest-earning money-market accounts and simply pay each month’s purchases all at once out of my monthly paycheck.  I’d either be constantly shuffling money back and forth or keeping a much larger portion of my cash in my checking account if I wasn’t able to time my expenses so they coincide with my income.

Yes, you need financial organization to use financial tools.

For the entire rewards argument to be true, you must first assume the best-case-scenario - zero balance, never late for any reason. No payroll mishaps, no direct-deposit miscues, no auto-bill-pay snafus, no network outages, no rogue reps in the billing department posting your check on the next day’s business since they benefit from your misfortune. The entire tangled web must function correctly. And that doesn’t even take you into account. On vacation, out-of-town on business, visiting the family in Hicksville (internet access = ZERO), blah, blah, blah blah, blah….

[the blah bit was in the article — not added my me — Deamiter]

It’s true, you have to be organized to take advantage of credit cards.  Similarly, if you purchase products based on a warranty you decline to read, you’re making poor purchases.  If you buy a house without reading the mortgage, you very well could be stuck with a horrible deal.  If you use a rewards card and carry a balance, it’s not the bank’s fault you are making a poor decision.  You should have put half as much research into your credit card as you did your television or microwave and gotten a card with a low rate instead.

Similarly, if you think there’s a chance that the credit card company will screw up your payment don’t pay at the last second — pay when you get the bill!  It’s also not that tough to plan ahead and pay your bills BEFORE visiting isolated relatives or going on vacation to Antarctica.  Totally aside from financing and mortgage payments, these objections apply equally to utility bills like electricity and gas as well as phone and internet lines — if you’re not organized enough to pay monthly bills, you will receive late fees.  If you are not organized enough to keep a few months of expenses on hand for emergencies, you should PLAN to pay fees when (not if) you don’t get paid or worse — you lose your job.

So why use credit cards at all?

So help me out here. Why? What is the draw? Do rewards draw you in like a moth to a light? Do you think you are winning because of your rewards/cash back/free hat?

I’m glad you asked.  I actually find it funny how blanket-opponents of credit cards repeatedly miss the point that credit cards are convenient.  And safe.  Oh heck, I’ll write up a list.

• I’ve used credit cards in the USA, in Canada, in England, France, Belgium, Germany etc… and they sure beat US dollars in terms of acceptance!  Yeah, there’s a fee, but not much more than to get cash (and yes, I carried cash for smaller purchases too).
• They reduce the amount of change and the number of bills I have to carry around.  My wallet is lighter and I worry less about losing serious cash if I get robbed.
• I’m not liable for theft.  Technically, I can be liable for up to $50, but I’ve never heard of somebody being asked to pay the $50.  If the card gets stolen, fraudulent charges are reversed.  If the card is just lost, I ask for another card to be sent and I lose nothing.
• Tracking expenses is simple.  Transactions are automatically downloaded to my computer.

What about rewards?  Well I don’t know who this particular blogger hangs out with, but apparently those with reward cards are “foaming at the mouth” (I’d check for rabies).  Personally, I don’t know anybody who purposefully pays with their credit cards just to get the rewards.  That said, if one rationally chose to use credit cards for everyday purchases for the reasons listed above, choosing a card with rewards helps to reduce the financial impact of credit cards on the economy.

The whole reason that rewards are possible — that most credit card opponents seem to miss — is that the interchange fees (fees to merchants) are much higher than they would be if there were true competition.  Honestly, the amount of infrastructure necessary to run a credit card business is HUGE (you need consumers to carry and use the card, AND you need merchants to accept the card).  With no competitors, the major companies have little incentive to reduce merchant fees since merchants would lose business if they stopped taking the cards.

Recently in Australia, a 0.5% interchange fee limit was put in place by the government.  I would be strongly in favor of similar regulation in America.  Of course, rewards cards would go away overnight, but in exchange, the prices of goods and cost of doing business (especially for small businesses) would drop.

In the absence of a more efficient economy, though, I will continue to use my credit card for convenience and safety — receive “rewards” that put less of the interchange fees into the hands of the banks and as always, I will stay organized and aware of the terms of my contract with the credit card company.  It’s really not as hard as some people want to make it look.

As mortgage lenders rush to revise their lending policies and greatly reduce their financial risk, credit card issuers are losing money(many of whom were bitten by subprime mortgage losses) are also pushing to return to their historically high, profitable margins. In 2007, credit card revenues rose 4% to 25 billion, but profits decreased by 35% largely due to rising delinquencies.

Bank of America recently sent out notices to it’s cardholders that they would be facing interest rate increases of 9% to 27% and apparently didn’t limit the increase to those with poor repayment histories.

Avoid higher rates as you pay off your balance

At a time like this when credit card companies are drastically raising rates, it’s extremely important to read all the fine print they send you. In many cases (as with the recent Bank of America increase) you can opt out of the rate increase if you make all your payments on time and stop making new purchases on the card. It’s vital to opt out in writing, and there are often a list of conditions and details you have to attend to, but if you’re working on paying off your credit card debt and don’t want your rates to double, the few hours it takes to keep rates low might very well be worth the effort!  Also be careful about acting on any information you receive over the phone.  Different representatives can give wildly varying responses to the same question and you should never consider any policy or agreement binding unless you have it in writing.

I’m not alone in considering interest rates in excess of 30% per year to be unethical, but at the same time I don’t see it as pure evil.  We’re seeing the true cost of offering high credit limits to nearly every American regardless of their ability to pay if they run up a tab.  Many industry practices are deplorable (like targeting those who have declared bankruptcy as they have a “taste for debt” and can’t declare bankruptcy again for years) but it’s nice to see the financial institutions getting bitten for their unchecked subprime lending.  Even more people will be harmed by this attempt by the industry to recoup costs and shed as many poor borrowers as possible, but when the dust settles, America will be a bit wiser and credit will be much more restricted for a few years.

The future of ubiquitous consumer credit

The really interesting part of the whole credit-card mess will be to see if anybody learns from recent events.  Eventually the economy will hit another long-term upward trend banks will go back to competing for ever riskier borrowers to try to beat each others’ quarterly profits.  Consumers will have recovered from debt or outlived the 7-year bankruptcy penalties and a new generation will have to learn the dangers of credit card debt all over again.

Even if the government steps in to try to regulate the industry and stop this financial disaster from being repeated, we can be sure that banks will find new, innovative ways to take advantage of consumers.  The real trick will be if we can educate the average American enough that they can make wiser choices about credit and debt in the future.  I’m ever optimistic, but I won’t be holding my breath.

I hate debt. I’ve come to see debt — even culturally and financially sensible debt like mortgages — as universally bad, to be endured when necessary but eliminated as soon as possible. Some of this can be attributed to my upbringing with two highly-educated, working parents who both grew up in families with little money. My parents taught me how avoiding expensive (and little-used) toys, cooking dinner every night, and by camping in Pensacola, Florida rather than splurging at Disney World, we could afford more experiences, more vacations and not sacrifice one tiny bit of fun or happiness (though I don’t think I understood when they first refused my request for a Nintendo). I feel rather lucky for having grown up with my family’s financial wisdom.

In reading some books on the history of credit cards and consumer debt, I’ve come to realize that this is a rather shallow view of the subject. While the vast majority of debtors in this culture have simply used debt to be able to live beyond their means without considering that debt siply serves to increase the cost of expenses, there are significant circumstances where debt makes sense and credit cards can create opportunities.

While I grew up generally feeling that debt was Bad, I never thought all debt was equally bad. Mortgages are pretty culturally acceptable and with reasonably low rates as well as largely respectable lenders, I don’t see them as particularly negative. On the other extreme, payday loans, which are largely marketed to the poor with extremely high interest rates (like over 300% APR) are about as bad as it gets. I’m focusing on credit cards here because they’ve become nearly universal in our society and are controversially seen by some as anathema and by others as a good way to finance a new TV.

When credit card debt makes sense

Credit card debt makes good sense for many new small businesses. Without a significant history of earnings, it is often extremely difficult for people starting a business to find loans — especially for operating capital. When working with large bureaucracies like the government, payment can be delayed a number of months after the contract is completed. The easily obtained credit via credit cards can allow continued operation while waiting for payment.

To be fair, credit card debt can also make sense for the general consumer when the costs are known and there is a concrete plan in place to pay off the debt. I have not yet experienced a situation where I would willingly pay 17% instead of saving patiently, but I can imagine that if a relative were very sick I might want to fly to visit immediately. As I have yet to build up enough savings to cover such an expense, I could fund it with my credit card and simply pay it back over the next few months.

Totally aside from business and emergencies, I can also imagine a time when somebody were willing to pay 20% more for a television or washing machine. I wouldn’t do it myself, but as long as they understood the ultimate cost and knew how they were going to pay it back, I’m not in a position to pass judgment.

When to run away

You should avoid credit card debt like the plague if you are not willing to sit down and figure out how much extra it will cost to finance your expenses and you know exactly how you will pay for the expense as well as how long it will take. Financing with the amorphous goal of “paying it back later” is a sure way to incur more debt than is wise. Similarly, building a plan for emergencies like a job loss is extremely important — when you have debt hanging over your head, simply cutting back expenses doesn’t work to keep outgoing cash flow very low.

Quite simply, if you don’t know exactly how long it will take to pay off the debt, how much extra the debt will cost, and also have a plan for an unexpected drain on your finances, you should cut up your credit cards and avoid credit card debt at all costs.

As for me, I will continue to use my credit card (yes, I only have one) because it’s the easiest way for me to track my expenses and a very convenient way to pay for things. At the same time, I will continue to avoid credit card debt at all costs. While I might never understand why people choose credit card debt, or why they think they can choose not to carefully consider the implications of high interest-rate debt, I can accept that they can make their own choices. I also know that there is a significant portion of debtors who wrongly assumed that “pre-approved” meant the bank thought you were capable of paying back the loan or were simply tricked into using the debt by banks who know that ignorance is the most profitable trait in a customer. Whatever the reason, I certainly won’t allow my negative feelings toward debt to extend to those who have debt!