US consumers have a debt total of $13.86 Trillion. This includes mortgages, student loans, car loans and credit cards. Now you would expect the average personal finance blog, or expert, to tell you that debt is a bad thing and how you should always strive to be debt free.
This however, is not your average blog. Debt is like a very sharp knife. It can be very useful if you know how to use it but lethal if you let it get away from you. Certain types of debt (like mortgages) is cheaper right now than it has ever been and in my next post, I will help you learn exactly how to use it to your advantage, but just like anything else, you have to eliminate bad debt habits before you can cultivate good ones.
For now, a simple rule of thumb you need to remember is – when you utilize debt to purchase a depreciating asset, you are doing yourself a disservice. A depreciating item is anything that decreases in value over time (furniture, car, motorcycle, boat, RV, clothes, shoes etc.). So whether you’re swiping a credit card to purchase a new dress at Macy’s, or financing that shiny new car, motorcycle or RV, what you’re really doing, is walking further away from actually achieving the American dream even though it temporarily may seem like you’re living it. You’re essentially paying exponential dollars on something that will lower in value every single day you own it. What you want instead is own an asset outright that will increase in value every day you own it (ex. a CD, bond or stock). The reason why the rich get richer is that they own the debt you take out and every time you pay interest, it goes straight into their pockets.
In my previous post, I wrote about how to create a budget that will enable you to categorize your spending and give more purpose to each dollar you earn and spend. If you are following a budget, you are likely spending money that you already put aside for that category. So technically, those new shoes you are buying are already paid for in your budget and you can just pay cash for it (instead of swiping). The physiological response of your body is markedly different when you pay cash versus when you use a credit card. There is scientific evidence suggesting that your body’s physiological response, when you pay for something in cash, is the same as it is when you experience physical pain. When you pay with plastic (credit cards) however, there is no such response. Here is a link to a Forbes article that talks about this research. Essentially, when you see real money leave your hands, it hurts, and it should. This feeling is important for two reasons – 1) You will value your purchase more, and 2) Next time you see a shiny pair in the store, you will know you endured pain for those shoes you are wearing, and you are far less likely to buy them unless you really need them.
From a big picture standpoint, what this ‘paying cash for everything’ habit will do, is help you recognize the fleeting nature of the joy that material objects bring you. This is another scientifically proven fact. A new pair of shoes, a new dress or a car only give you a temporary dose of excitement, and very soon you are left trying to figure out how you are going to score the next one. It is a vicious habit that is hard to kick, but having a budget and paying cash for each score can make a big dent in the number of cravings.
The average American household owes approximately $8300 in credit card debt. Credit cards normally will charge you about 20% interest rate. That means, the average American household pays $1660 in interest every year. So then the 128 million households in the US pay a total of $212 billion in interest every year. No wonder banks are sending you pre-approved credit card offers and enticing you with all the amazing things you can do with points every day. That great deal you found on the new Air Jordans and paid $150 for, you are in fact paying $180. Only difference is, you’re paying the bank $30 instead of the store.
The bottom line is, unless you have the cash to pay for something, do not use a credit card if you want to have any chance of being actually rich someday. Its that simple. Once you’ve cultivated this habit of not purchasing anything unless you can pay for it in cash, it is time to tighten the screws even further. It is time to start saving. Try to keep the cash you have until the end of the month and use it to pay down debt. It could be $20, $5 or $1. Every dollar counts.
Let me put some numbers down for perspective. Let us assume you are that average American household and have $8300 in credit card debt. Below is a comparison of what happens when you make $150, $300 and $450 payments every month on that same credit card debt with a 20% interest rate.
With the $150 monthly payment, you will pay nearly three times as much as you owe and will keep paying for 13 years. Doubling your payment cuts your total paid to less than half and reduces the time to payoff by 10 years. Triple the monthly payments and you’re done in less than 2 years. If you have a car loan and credit card debt, get rid of the car and buy a really old, cheap car that will shuttle you back and forth reliably, and use the money you save from not having a car payment to pay down your credit card debt. I call these ‘High Impact Money Moves’ or HIMMs and making a few HIMMs can make you a millionaire in a matter of a few years. Driving an old car for a few years now will give you a real shot at becoming actually rich. Driving your ‘nice’ car now will mean you are forever going to wonder why the system is failing you. You will be constantly stuck in your daily grind because your monthly bills and payment obligations never seem to go away.
If the above numbers don’t convince you, I don’t know what will. Think about it this way. Every time you purchase something with a credit card without having the ability to pay off at the end of the month, every dollar you spend is actually way more than a dollar spent. Barring payday loans and loan sharks, credit cards are the biggest ripoff in the history of ripoffs.
I will say again because it is that important, if it is going to be worth less tomorrow than it is today, you should not be getting into debt to buy it.
In my next article, I will share with you, what items you should be purchasing with debt. Debt is cheaper today than it has ever been and I will tell you exactly how you can use it to make yourself wealthier. Hit the subscribe button so you don’t miss the next article. I promise not to spam you.