Consumer Debt is Deadly

The purpose of this Cash Ideas Now blog is to help you identify ways to make money.

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Any attempt to free yourself from your job routine begins with getting your financial house in order, and one of the biggest obstacles you must overcome is consumer debt.

To put it mildly, consumer debt is a financial killer.

One of the best ways to reclaim your financial future is to repay those high interest consumer loans and then restrict the use of credit cards to emergencies and fast investment cash.

Therefore, the third step in creating wealth is to reduce your dependence on credit cards and ensure future monthly payments on all of your cards combined never exceeds 10% of your after tax income.

Consumer debt is usually used to finance the purchase of “nice to have” things--which typically depreciate in value. Whereas, investment debt is the use of financing to purchase things which go up in value, like real estate, antiques, and well-run businesses.

Consumer credit increased at an annual rate of 2.5 percent in May 2006, while revolving credit increased at an annual rate of 10 percent. The Federal Reserve Statistical Release for July 10, 2006, indicates Americans currently owe over 808 billion dollars in revolving debt, which is principally credit cards and auto loans, and over 1.3 trillion dollars in non-revolving debt. According to U.S. Bankruptcy Court statistics, there were well over 2 million bankruptcy flings made in 2005 alone, with the vast majority of these non-business related filings. Remember, there are approximately 123 million working Americans; therefore, this number represents nearly 2 percent of the working population. The abuse of credit cards by the American consumer has become a financial epidemic.

The propensity of Americans to assume high interest credit card debt, while fearing the use of debt to make intelligent investments, is mind-boggling.

Consider this example. A new car may cost you up to $500 per month. At the end of 5 years, you will have a significantly depreciated car, with a loss of $30,000 or more in principal and interest payments. Compare this to purchasing a rental property. In the worse case scenario, you may expect to make payments during vacancies, provide for unscheduled maintenance, and carry a negative cash flow from month to month. However, at the same time you will be enjoying a property that appreciates in value, while giving you a valuable tax write-off. Appreciation and tax write-offs are not the primary reason to get involved in real estate, nor is carrying a negative cash flow a pleasant thought. But, in the long run, this is more advantageous to your wealth goals than the car loan.

As a credit consumer you should also protect yourself against the dreaded Universal Default Clause. Amazingly, a large percentage of major credit card issuers have this clause tucked into your user agreement. Essentially, the Universal Default Clause allows your credit card company to significantly increase your interest rate and fees based on your credit score and payment history with other lenders, including your home and car loan. Watch out for this clause and try to avoid doing business with credit card companies that use this tactic to prey on their less sophisticated customers.

If the fear of a foreclosure is your greatest concern, it is interesting to note that according to RealtyTrac, there is one new foreclosure filing per month for every 1,311 U.S. households.

Over the course of a year, the number of homes entering foreclosure barely compares to the 2 million plus bankruptcy filings per year, suggesting the risk to your financial well-being through home ownership is lower than that of acquiring consumer debt. Education in this area is critical to your success, so I strongly recommend you read books by Tyler Hicks and William Nickerson before starting a property investment plan.

The next time you are tempted to take out a loan on a new boat or quad, consider how the cost of this purchase, with compounding interest, may be better used to achieve your financial goals. The National Foundation for Credit Counseling believes it takes from 3 to5 years to recover from credit card debt, once an individual starts a structured recovery plan. This can put a severe damper on your wealth accumulation goals. What it all comes down to is your willingness to delay gratification—a difficult emotion to master.

Over the years I have used credit cards for both consumer purchases and investments. Sadly, like many others I also went through a stage in my life where I abused credit cards and allowed the balances due to become a burden to my family and a drain on my monthly income. I used steps one and two of this report to dig myself out and have since limited myself to carrying a prepaid card. Normally, people use prepaid cards when they can’t qualify for a regular credit card. However, the prepaid is also a great way to minimize your spending, as it only works when there is money in the bank to back up your purchases.

Credit card horror stories are everywhere, and there is a good chance you know somebody who has experienced something similar to this:

A young college student received a credit card offer in the mail. As a full-time student, he did not have a steady income and wondered how he managed to qualify. His credit rating was based entirely upon his potential to earn income as a future college graduate, and the complete lack of negative information in his file.

The student carried his freshly minted card in his pocket for several weeks, resolved to never use it, except for an emergency. Near the end of the semester he and a few classmates were pulling an all-night group study session in preparation for final exams. Around midnight somebody suggested they call out for pizza. They pooled around twelve dollars in cash between them and nearly gave up in frustration when our hapless credit worthy student volunteered his credit card. It was a small beginning, as these things typically are, but credit use is like an addictive drug. It is so easy to use, and the pain of repayment is always somewhere down the road—too far away to be associated with the enjoyment of pizza tonight.

By the end of the school year, the student had accumulated over $1,000 in debt on his card. While his monthly payments remained small, they represented a significant strain on his budget. His monthly allowance from home was now being spent to make credit card payments, which meant he had to use the card to make more routine purchases. The balance grew out of control, leading to a destroyed credit rating.

Another example of credit card use involved a young lady who worked a low paying job. She had dreams of a better life and spent a lot of her time looking for real estate investment opportunities. She carried four credit cards, with an available cumulative balance of around $12,000.

One day after work she came across a small house for sale by owner. It needed some work, but following an analysis of the market, she knew this home was worth more than the asking price. Using the cash option on her cards, she obtained $10,000 to make the down payment and cover closing costs. The owner carried the financing at a fair interest rate.

After closing she immediately set to work cleaning up the property. She then had it professionally appraised (insist on appraisals from Member Appraisal Institute) and listed for sale. For three months she managed to make the minimum payments due on her cards before the house eventually sold for a modest profit. At closing the buyer assumed the loan due to the original owner, leaving a little less than $20,000 profit. She immediately paid off her balance due on all of her credit cards, and parked around $8,000 in her bank account. While her return is not impressive to some investors, she did manage to make $8,000 out of nothing but information and gumption.

Both of these stories illustrate the power and dangers of credit card use. While it is not advisable to get involved in investments using credit cards, it is an option when quick cash is needed to capitalize on opportunity.

As a wealth builder it is vitally important that you monitor your credit report and correct any errors immediately. One of the easiest, and cheapest ways to obtain your personal credit report is over the Internet. It is estimated that up to 60% of all borrowers request a credit report at least once a year. If you are trying to protect your privacy, you may want to be wary of the questions about your current address, phone number, employer, and other personal data they may ask in the “Request Your Credit Report Here” form. A recent amendment to the federal Fair Credit Reporting Act requires each of the nationwide consumer reporting companies, Equifax, Experian, and TransUnion, to provide you with a free copy of your credit report, at your request, once every 12 months. Use the FTC government website www.annualcreditreport.com as your primary source for credit report data.


Ron Taylor
Your Work Sucks Super Hero