Wednesday, March 18, 1998

Credit Me With These Random Thoughts
Or, Would You Rather Pay For Today Tomorrow Or Tomorrow Today?
By George Runkle (TMF Runkle)

A few months ago, Dayana Yochim (TMF School) asked me to spend some time in the Credit Card message boards on our AOL and Web sites. I have to admit, I was not really happy to do it. Credit cards are a sensitive subject, and many people have real problems with them. I'm not so proud of my own record in the past twenty years either. I thought I'd take this opportunity to write down a few of my discoveries and thoughts about credit.

One of my early surprises about credit is where you find people who are overextended. Years ago, when I was in college, I supported myself by dispatching home heating oil at night. While people were generally on an automatic delivery system, sometimes the system failed and they'd run out of oil. When they called, they were usually polite, and happy we took care of them quickly.

I could always tell, though, when the people calling had run out of oil as a result of their credit being held. First, they were always angry when they called. Second, they invariably lived in either Chevy Chase or Potomac (the two richest suburbs of the Washington D.C. area). People in the middle class communities of Rockville or Kensington never seemed to forget to pay their bills. Why did "rich" people not pay their bills? Probably because many of them weren't really rich; they were just living beyond their means. Why were they so angry? I suppose a lack of emotional maturity, or maybe they thought they could intimidate me, a lowly minimum-wage dispatcher, to send them oil. It didn't work; the owner didn't like giving away fuel oil, no matter where you lived.

What is it about credit that gets so many people in trouble? The same thing that makes it convenient. Buying something on credit allows you to get it today, instead of saving for weeks, months, or years to get it. You certainly wouldn't want to have to save for twenty years before you bought your first house. When the old Foolmobile went to the junkyard in the sky (or most likely the gravel used-car lot in West Virginia), I couldn't wait five years to save for a new car. Even if you had the money in cash for a house or a new car, would you want to drop it all in that one place? I wouldn't.

But from houses and cars, we can often get into ridiculous uses of credit. Like a friend of mine in the Army who borrowed money to buy a stereo. I've even seen a tropical fish store that would sell you a fish tank on credit. Certainly, stereos and fish tanks don't need to be bought right now. Furthermore, it doesn't take that long to save for them. However, many people go for what they want now, and get stuck in the credit trap.

Look at the return you can get from lending money to someone who wants to buy a fish tank on credit. It's easily in the 15% - 20% range, sometimes even higher. No wonder so many merchants push credit, and you will get all sorts of solicitations in the mail. A balance of $10,000 invested at 21% will get you $67,274 in ten years. It's worth the default risk for the credit card companies.

Now, what happens if you default on credit cards, consumer loans, etc? The creditors make your life miserable, you cut down on the only expense which is elastic (eating), and nasty things happen to you. If you can't pay your utilities, you can be in the dark without water and heat. You can be evicted, or the bank might foreclose on your house. I've witnessed an eviction or two in my poverty-stricken days; they really do put your furniture on the sidewalk. Ultimately, you can go bankrupt.

What happens in bankruptcy? In the old days, they came and auctioned off your furniture, threw you out of your house, and you were lucky to keep your clothes. Today, it's not so severe. You can keep your home and car, and many of your possessions are left untouched. I asked a bank loan officer why you wouldn't want to go bankrupt instead of paying off debts. His answer was, "I'll never give you a loan if that happens." He said you are stuck with the shyster lenders that stick you with 21% or higher rates. You won't get a mortgage loan, and may have a hard time getting a car loan (which won't be at a decent rate). Oh, renting a place can be hard too. Landlords, unless they are real hard up for a tenant, won't rent to you if you've been bankrupt. The risk is too great, and eviction takes too long. My friend the loan officer said that once a person goes into bankruptcy, it often starts a cycle of bankruptcies. Of course, there are times when bankruptcy is inevitable, for example when things happen beyond your control (medical expenses, lawsuit, and unusual economic disasters). In such case, future creditors are more understanding.

So, in the end, abusing credit can have some very dreary results. The one common thread is it happens when you push for things today that could have waited until tomorrow. So, instead of having less today, tomorrow you have nothing.

[Hey, Fools. If you've got a balance on your plastic, don't miss our Foolish tips on how to pay it down!]

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