The Problem With Credit: Don’t Rent Your Money

Update (6/7/09): This article was selected to be one of “The Best of the Best in Money and Personal Finance!”

Overspending is one of the biggest problems that Americans have faced in the last few years, and it often occurs because of the ease by which we can get credit. Borrowing money is not difficult; even the most reputable of banks have been behaving as irresponsibly as the worst loan sharks (albeit at better rates!).

This has tempted even the most un-credit-worthy of people to foolishly borrow vastly more than they can afford. Consumer debt is charged at high interest rates – especially that on credit cards – and it is clearly bad for anyone’s financial health. Not only are people facing those payment charges and penalties losing money, but the impact on their overall finances is terrible. Interest and penalties are not tax-deductible, making cash-flow that much more of a problem.

Consider the interest penalties on even a few thousand dollars of credit card debt. Let’s pick $10,000 on a card charging you only 18% (though it seems high, this is actually quite low for overdue credit card interest rates). That makes $150 per month in interest charges (assuming you are only paying the interest!) that you must pay. Now consider that in a 25% tax bracket, you actually have to earn $2,250, then pay another $450 in taxes before you can pay your interest payments. Only then do you pay the $1,800 that year for the use of that $10,000 – and you STILL owe the ten thousand!

This means that your hard-earned money is going to pay someone else for the ‘rental’ of that money! Not paying off your credit cards early lets other people benefit from compound interest at your expense.  This is not financially healthy at all. By using controlled borrowing and paying off your debt at the end of every month, those thousands of dollars could be in your savings or in your pocket at the end of the year.

Do. Not. Rent. Your. Money.

A lot of people have trouble with this concept, especially those that earn a lot of money. It can be difficult to track where your money goes, and I know a lot of people who have the biggest expense category of ‘miscellaneous.’ Remember that uncontrolled discretionary spending – especially that in your V/D category – is where the worst cash flow and financial health issues can arise.

I have found that many people are extremely surprised when they set up their expense log. Finding out the total amount that they spend and accounting for all of their ‘miscellaneous’ costs really show how the small, regular routines – the morning coffees, the ATM charges, and the silly little frivolities we all indulge in – really add up quickly. Impulse spending is generally a major contributing reason for financially unhealthy credit card borrowing and spending. So remember! If you put it on a credit card and don’t pay it off, you will be renting your money.

Don’t.

Tags: Budgeting, cost benefit, credit, credit card, debt, discretionary, expense log, finances, interest, savings, The Expense Grid, variable, waste