Tuesday, December 22, 2015

52 Weeks to a Simpler Life – Tip #16 – Pare Down Your Credit Cards

Let's face it! Many, and possibly a majority of the people in the U.S., and probably the other developed nations around the world, don't actually own most of their most valuable possessions.

Say what? I bought my house/condo. I bought my car/SUV. I bought my boat. I bought my RV. I bought my wife's/fiance's diamond engagement ring. I bought my kids' educations. I bought all those Christmas presents. I bought these designer clothes. I can go on and on with this list, but I'm sure you get the picture.

Yes! You did buy all those things and much more. But, and this is a big “BUT,” did you actually PAY for all this stuff? Ah! There's the rub. According to research readily available on the Internet, approximately 66% of all the “owned” homes in the U.S. have a mortgage. As of 2013, approximately 85% of all private vehicles are financed. The same holds true for the other items I listed.

Some Real World Statistics

Wrap your head around this:
  • U.S. Credit Card Debt - $ 923,945,000,000
  • U.S. Mortgage Debt - $13,803,040,000,000
  • U.S. Auto & Other Loans - $ 1,294,140,000,000
  • U.S. Student Loans - $ 1,321,869,000,000   
(as of approximately 2:00 PM December 22, 2015 and it's increasing)

Yes, those are billions and trillions. As a matter of fact, the amount of U.S. credit card debt stands at more than $300,000,000,000 (BILLION) more than the requested Department of Defense budget for 2016 of the largest, best equipped and only Super Power military in world. And, just think about this. The requested budget of the entire U.S. government for 2016 is considerably less than ONE-third the amount of the U.S. Mortgage Debt. The total consumer/private debt represented by just the four figures noted above is over $17,000,000,000,000 (TRILLION). Compare that to the entire national debt of the U.S. government at $18,795,753,000,000 (again, as of the date/time noted above).

Let's face reality. Most people in the U.S. don't own much of what they claim to own. If you have a mortgage, your mortgage company owns and controls the deed to your property. If you have a vehicle loan on a car, SUV, boat, RV, etc., the finance company owns and controls the title to that property. If you have a student loan, regardless of if it was taken out by the student or the parents, whoever has the loan in their name is obligated for the rest of their life to whoever owns that loan until it's paid off, if it ever is. And, the nearly a trillion dollars of credit card debt is owned by the “big money bankers” (as is all the debt, actually).

You may have possession of a lot of “stuff,” but you didn't pay for it and unless you pay off your entire credit card statement every month, you didn't save much when you bought it. You may ultimately pay more for it through finance charges than if you had paid cash.

Credit cards are convenient and, obviously, with the use of this plastic card – and now, rapidly being adopted, with just passing your smart phone over a payment terminal, it is so easy to buy “stuff” whether a necessity or just a spontaneous purchase.

Free or Not Free?

That's a real question. If you possess things that you owe anywhere from a few dollars and a month to pay off or you possess things that someone else holds the title on and you have months or years to pay off, you are not free.

People often think buying anything used is indicating a less than financially successful person. But, analyze that thinking. Let's use a car as an example and you finance that car for six years. You are actually buying a six year old used car. It really doesn't matter if you actually purchase and finance the vehicle or you lease it (which, to me is, probably, not a wise position unless the vehicle is for business under the current tax codes). Yes! You get to use the car. But, you have the same responsibilities and obligations to register, insure, maintain, keep the car in operational condition and realize the vehicle depreciation. At the end of the finance agreement, you finally own a six year old, used car. Worse, yet, if you lease it, at the end of the lease period you own NOTHING! And, you probably paid a buy-in to commence the lease (that's the leasing company's profit, up front) and if you have driven it over an allotted number of miles, you'll pay an add-on mileage charge for every extra mile. Plus, there is a buy out amount if you want to keep the vehicle at the end of the lease. Additionally, if you don't return the car in the condition stipulated in the lease agreement, you may pay a sizable penalty. All that, to own NOTHING.

As long as you owe anyone for anything, you are not free. You always have the debt over your head. And there are four factors to take in to account when you enter into any debt arrangement.

  1. The contract law factor
  2. The ethical factor
  3. The moral factor
  4. The self-esteem factor

Depending on who you are, one, several or all of these will weigh heavily over you. You are not free. I'm not going to pontificate on any of these factors. These are all matters you have to consider for yourself.

Pare Down Your Credit Cards

So far, it may have been sounding like I'm negative about credit cards and the use of them. However, that's not actually the case. What I want to suggest if you want to live a simpler life is that you get rid of extra credit cards and only retain one or two depending on your own thinking and variable factors.

I'm addressing this subject from a position of personal experience. But, I'm also addressing it from the advice and counsel of just about every financial advice professional in the U.S. I'm sure the same advice applies to the rest of the developed world as well.

Plastic Money” is easy to come by today. It declined for a while after the Great Recession of 2008, but has been coming back strong since then. It comes in several forms. It may be in the form of a debit or bank checking account card, probably the best kind of card depending on how you use it. It may be in the form of a charge card. You can charge on it, but you can't carry a balance over from month to month. It can come in the form of a credit card. You can use the credit card as a charge card or a credit card to carry a balance over one or more months. Those are the three primary forms of plastic money most people are familiar with. There, of course, is direct payment via ACH debits from your bank account, but that's matter for another time.

At least twice in my lifetime I've carried as many as 8 to 10 credit cards and at least one or more charge cards. In addition, I also had debit cards from my checking accounts. Through these credit cards, I accumulated enough unsecured credit to minimally acquire a new car, even a higher priced Mercedes, BMW, Jaguar or other luxury cars. Pretty good, huh?

Here's the problem with that. Most of us start out with the best of intentions. We get our first card. We use it responsibly (for the most part) and our credit rating rises. Other credit card issuers want a piece of the action, so without our knowledge, they acquire lists of “creditworthy” prospects and send unsolicited offers via the regular mail or email offering us another card with lots of incentives including a healthy credit limit. So, we say, what the heck, the deal looks better than my current card, so we accept the offer. Now, we have two cards.

Everything is just fine, we actually continue using the first card, but now we've transferred a balance over to the new card at a '0' finance charge for, perhaps, 12 months. We make our monthly payments. We have more buying power, so, perhaps, we buy a little more than we did before. Then another card offer comes in because your credit rating is getting better. And you accept it. Then a fourth, fifth, sixth, seventh and so on. Again, we accept them with the intent to use them responsibly.

A couple years go by. Somehow, we just can't quite put our finger on it, we have acquired a lot more “stuff.” We are now making monthly payments on seven or eight different accounts. And, we're carrying an average monthly balance of over $15,000.00, the average credit card debt held by the average credit card user. We have a total, combined credit limit of $100,000.00 dollars and our credit rating looks great. But, somehow, we are now making combined payments amounting to between $425.00 and maybe $750.00 per month depending on the terms of the various credit cards. That's a big chunk of change every month. Interestingly, what you bought to accumulate that $15,000.00 of carryover debt, just doesn't seem to still hold the same value for you.

It's probably important to remember that a portion of each payment is interest or, as the credit card company calls it, finance charges. The current average is a minute percentage over 15%. For an example, let's just call it a flat 15%. So, if you happen to be carrying the average credit card debt of $15,000.00, the monthly amount deducted from your payments will be $187.50 for the finance charges. In a year if you retain that average level of debt on your cards, you're going to pay $2,250.00 just for the privilege of purchasing a lot of stuff you can't see the value in any longer.

I'm making this a very simple example of the complexity of credit card credit and the way it complicates your life. I am not going to get into the added complexities of over limit charges, late charges, charges to transfer balances and other charges related to the use of credit cards.

Let me touch on a couple other things. Earlier I mentioned “charge cards” that don't allow you to carry over a balance from one month to the next. There are basically two kinds of charge cards. There are cards issued by companies like American Express, Diners Club, Carte Blanche and probably a few others. These cards are probably most often used for business purposes. While most credit cards don't have a membership fee (although there are some with annual fees), the charge cards issued by the companies I just enumerated typically require a 'healthy' annual membership fee. The base card and membership fee holds nothing more than the privilege and, supposed, prestige/status of using the card.

But, for an up charged membership fee, you'll receive some extra features, benefits and elevated “status.” You might have started out with a basic “green card” for the $35.00 fee, but for $75.00 you'll get a gold card and reward points for every dollar you spend. For, perhaps, $150.00, you'll have the word “Plus” added to your card and you'll get double reward points. For a mere $325.00, you'll receive the Platinum card with some additional features and lots more status. And for $450.00, you'll be at the Black Card level that only the most elite, highest status level individuals may “earn” the privilege of carrying.

I don't know if these membership fees are accurate currently, I stopped carrying any American Express cards several years ago. I haven't had a Diners Club card in decades and I think I may have had a Carte Blanche card 30 or more years ago. For the average person, these cards aren't worth buying (literally) into. But, the appeal for status and prestige is strong. I got hooked as have many of my business colleagues. Beware of the trap.

The other kind of charge card available is typically issued by gas stations. These cards usually don't require any membership fee and are issued basically on your credit rating. The balance is due at the end of every billing period. You can typically only use them at the oil/gas company that issues them. So, they are limited in scope. You can almost universally use a Visa or MasterCard or a debit card at any gas station. So, carrying a number of gas charge cards can just complicate your life, not simplify it. I've been down this road, too.

The Credit Rating Scam

Yes! I called it a scam. Why would I say that? Simple! A group of people, sitting in little cubicles with a bunch of computing devices and a very complicated program who wouldn't know you if they walked into you in the lobby of their building, make judgments and decisions about you that can impact your entire life. They can determine by issuing a number whether you're worthy of financing a home, a vehicle, a loan to educate your children or put clothes on their backs or food on the table. They can even, through that number, determine if you can get the medical treatment you or someone in your family needs to save his or her life.

That, my friend, is a hell of a lot of power. And who wields this mighty power? Why, ultimately, the banking cartel. Here is an example of how you can do the right thing and have the credit/banking industry count it negatively against you. In a few moments I'm going to again call you to action to get rid of all extra credit and charge cards you have. But, if you do it the wrong way, even though it's the right thing to do, your credit rating and creditworthiness will suffer, potentially, severely. Let's say you have that $100,000.00 of credit you've gained through eight credit cards. Then let's say you've decided to simplify your life by getting rid of six of those credit cards. Before you get rid of the cards, you are using only $15,000.00 or 15% utilization of the $100,000.00 of available credit. This is VERY GOOD and helps boost your credit rating and credit worthiness. You are a good financial manager. A+ to you.

But, now you eliminate or close six of the credit card accounts. They are all paid off. You never had any late payments or over limit fees. You may have never carried over a balance on some of them. But, that doesn't matter. The two remaining credit cards you're retaining have a combined credit limit of $20,000.00 and you are carrying the same $15,000.00 in debt on those two cards. This means you are now utilizing 75% of your available credit, even though you haven't incurred any additional debt.

This is a major NEGATIVE. You are no longer a good financial manager. It doesn't matter that you've never had a late payment or an over limit charge. The utilization of 75% of your available credit is going to lower your credit rating by a sizable amount because you're obviously, not creditworthy. If you go out to finance a house or vehicle, you'll likely be penalized and, IF you're approved for the loan, you'll likely pay a significantly higher interest rate.

Don't you just love how people who don't know you can control and mess with your life? That is only one of the caveats of the credit, banking and credit card world.

The Bottom Line

There is a lot more we could explore with regard to how credit cards, for all their convenience, can make you life considerably more complicated. I think you get the picture. So, IF you are one of the many, many people who have too many credit cards, even if you don't use them, the best thing to do is start paring them down to no more than one or two.

Don't just close the accounts, immediately, however. Analyze all your cards and determine which one or two are the best to keep for your particular lifestyle and purposes.

First, plan to eliminate the charge cards that require an annual membership fee. Cash in any reward points you may have accrued before you do. You paid for them.

Next, if you have any Visa or MasterCard cards that charge an annual fee, put those at the top of the list to eliminate.

Third, if you have cards that you never carry over any balances from month to month, select the cards that give you the most valuable reward program whether it's reward points or cash back. They may have higher interest rates, but it doesn't matter if you don't carry any balance over.

Now, select the “best of the best” cards, one or two (possibly a third, but only for a specific circumstance I'll describe in a few moments). Those are your keeper cards. Take all the other cards out of your wallet or purse and lock them up in a lock box, safe deposit box or somewhere out of sight, out of mind. Pay off the balances on any cards you are carrying over balances on (hopefully they are the cards with the lowest finance charges). This is going to lower your debt to credit ratio.

Once these cards are paid off (as quickly as you reasonably can), as they come up for renewal, cancel them, one at a time. Since your debt is lowering, it should have minimal impact as you lower your credit limit. Don't let the debt to credit ratio get any higher than it is when you begin your credit card downsizing and simplification project. This may take a year or two and maybe a little more. Make a plan and follow it.

Keep at least one card, the best of the best. If you decide to keep a second card, either use it as a back-up or for specific purposes. For example, I have one card I use only for personal expenses. I carry little cash with me, so I use my card for all purchases, even a $2.00 lunch at McDonalds. When my statement comes in each month (electronically) I can go over it and see exactly how I spent my money and the card becomes a money management tool. I use the second card only for business expenses for my small business. This keeps the business expenditures separated from the personal and again, provides a money management tool and a bookkeeping tool for my accountant.

If you are a traveler, you might use one card for personal expenses and one for travel expenses like gas and maintenance on your van, RV, boat or however you travel.

I also mentioned possibly keeping a third card. This is what I call the “Catastrophic Card.” You NEVER use this card, except maybe once a year for a minor purchase just to keep the card active. Ideally, this card would have a reasonably high credit limit, the lowest interest/finance charge rate and you don't care about reward points or cash back. You will ONLY use this card in the event of a catastrophic event. What do I categorize as catastrophic? A serious medical emergency that your health insurance, Medicare or Medicaid doesn't cover. A major vehicular breakdown if you travel in a van, RV or boat. It may be necessary to cover a large repair expense or even vehicle replacement. It may be necessary to stay in a motel/hotel for a short period while said repairs or replacement are taking place. Basically, if you decide to maintain a “Catastrophic Card” you treat it like it doesn't exist, but if there is a catastrophe, your back is covered.

Tip #16 of the 52 Weeks to a Simpler Life series is Pare Down Your Credit Cards. Be frugal and careful in your spending. Learn to use one or two cards at the most for convenience, record keeping and as a money management tool. Keeping the other facets of your life simple, minimal and frugal will be supportive and supported by limiting your credit cards and credit limits. But, by no means should you not live your life to the fullest extent possible.

Live free and be happy. EH

1 comment:

Richard Rosen said...

I don't use debit cards because there is no recourse should you dispute the purchase, not having the credit card intervene should your efforts with the vendor fail. Also, I don't like a debit card number out there where if stolen my account could be emptied.

I have a no annual fee American Express card which I use predominantly. I receive a good annual cash rebate, although I'm not happy with the high rates they charge merchants compared with Visa, so I'm reconsidering it main use. However, they double the warranty of what is bought with the card and that has helped out quite a bit over the years. Visa may have that as well.

Thanks for the great review Ed.