RateWatch #373 – The P-Monster - Credit Card Abuse
September 13, 2003 by Dick Lepre

What's Happening

Retail Sales were +0.6%, Consumer Sentiment fell to 88.2. Neither of these is bad but neither indicates strong economic growth. To some extent, this led to lower rates on Friday. PPI was +0.4% overall and +0.1% core. Monday has Industrial Production and Capacity Utilization. Tuesday has CPI.  Friday's rally is overdue technically but should not be seen as a reversal of the longer term bear market.  This provides a nice window for locking.

The Plastic Monster

Several years ago I did an internal report to assess the conversion rate of our on-line mortgage applications.  Without going into all of the details, let's just say that the rate was unacceptably low.

What was striking about the data was the relatively poor credit quality of a large set of loan application that we were getting.  (Interestingly enough, the credit quality of our leads in recent years is much higher.  I wish I knew why.)

There is a profile of those applications:
- a married couple
- young
- entry level jobs - quite possibly their first
- at least one car payment
- too much credit card debt

How to Start Using Credit Cards Correctly

A long time ago - when I was graduating from college, even before I actually started my first
job - I was sent applications for credit cards. They were very easy to get.  They still are. Young folks getting their first jobs are introduced to the world of credit cards.  Credit cards are a modern necessity but for some they become a serious problem.  Credit card debt can destroy young people's lives.

This section is for people getting started in the credit world.

If you want to become a homeowner you need to have credit cards work for you.  It is OK to get credit cards.  It is OK to use them. The purpose in using them should be to establish a credit history. What is not OK is carrying any sizable credit card debt.

Let's say that you want to buy a new TV for $700. Do not do it unless you have the $700 set aside for the purchase.  If you are not the best in the self-control department, perform this drill: 
buy the TV on your credit card only when you have the money in your checking account.  When you leave the store (OK you can take the TV home first but you can't plug it in yet) go to your bank and get a money order made out to the credit card company for the amount that was billed.  Go home, take the TV out of the box, plug it in and Scotch tape the envelope with the check to the top of the TV.  Mail it (the check, not the TV) to them when you receive the credit card statement.  You will have accomplished two things: 
1) established credit usage and good payment history and
2) not run up any debt.

Obey the following rules when using credit cards:
- use them infrequently
- do not buy anything that you do not have the money in hand to pay for
- pay off all of your credit card debt when you receive the statements.
- do not let the balance go over 50% of the credit limit. 

If you use a credit card for business and get reimbursed make sure that you still obey the
"no more than 50% of the credit line" rule.

At present, I use credit cards only when
1) shopping online and
2) when purchasing gasoline
3) in an emergency. 
4) sometimes, when making larges purchases where I get 1% back on my Visa card and pay the bill immediately.

If you want a DVD and do not have the cash then you cannot afford it.  Wait until you have the cash and pay cash for it. 

If you feel that you need to get away for the weekend and do not have the money - stay home and
watch TV.  Watch cartoons on Saturday and football on Sunday. 

Don't go to restaurants and put it on your credit card - pay cash. If you don't have that kind of
cash - eat at McDonalds.  If you cannot afford that then you really are in trouble.

Have some understanding with your spouse that spending for birthdays and the anniversary will be limited to cash-on-hand. Mutually agree that you love each other but that your love would be
enhanced if you could buy your own house some day.  If you are not married then be grateful
that you do not have this problem. Avoid getting a lot of credit cards.  When the kindly woman at the cash register at Macy's asks you if you want to apply for a credit card and tells you that you will get 5% off whatever you buy that day - resist.  She is working for Satan. She represents the forces of evil even though she looks innocent. She is out to destroy your credit.  She probably owns apartment buildings and wants to make sure that you become a permanent renter.

Do not succumb to the concept that we live in a "credit card economy" and that using credit cards helps the economy.  I suppose that in the 1970's people bought cocaine and cocaine dealers made money and that gave the economy a boost.  In the long run neither drugs nor credit card debt really helps the economy.  Those who are ruined by them become economically marginalized. 

The Credit Industry

If you look on-line you will see that there are thousands of listings for credit cards, debt consolidation, credit repair, debt counseling and bankruptcy.  The credit card industry has spawned other new industries.

What Should You Put on Your Credit Cards?

On-line shopping, emergencies: tow trucks, bail.  Use them also as a "deposit" when traveling.
You need them to make hotel reservations and to rent a car.

Debt Consolidation

I typed "debt consolidation" into Alta Vista and it said "27,578 pages found."

I typed "+"debt consolidation" +bankruptcy" and it said "12,303 pages found."

Feeling frisky I typed "+"debt consolidation" +bankruptcy +suicide" and it said "60 pages found."

Draw your own conclusions.

The Plastic House

In the past few years we have seen a mutant form of the plastic monster.  It is the 125% LTV mortgage. The proposition is simple enough - pay off all of you credit cards by getting a second mortgage on your home.  The interest is probably less that you are now paying and it may be tax deductible.

These are ill-advised.  The wrong people get them. People who have problems meeting their credit card debt now tie this debt to their home and can charge more stuff. 

Let me draw an analogy.  Around the year 1900 the German pharmaceutical firm Bayer (the aspirin people) marketed a cure for morphine addiction. This wonderful product was sold under the trade-mark "heroin." The 125% LTV loan may likely do to your finances what heroin does for your body.  Seems like a good idea at the time - feels good at first but it's nasty and hard to get rid of.  It is no more a cure for credit card debt than heroin was for morphine addiction.

If you are in this credit card abyss you need to work very hard to get out of it.  You need to stop charging and seriously do all that you can to maximize your income. You need to pay off the credit cards with the highest rates first.  If you work overtime or get a second job do not reward yourself for it.  You have already spent the money that you worked so hard for. If your debts are so large that you cannot possible pay them off with a 3-year austerity program you need to consider a bankruptcy. This will have a negative effect on you creditworthiness for years to come but you may beable to regain control of your life and do away with the hideous effects of being a captive of the P-Monster.

Living With Plastic

Credit cards are a necessity.  Get them.  Use them wisely.  Make them work for you by enhancing
your credit history.  Don't charge anything that you do not have the cash to pay for.  Pay all
credit card debt off immediately unless there is an emergency.

Not Just Plastic - Other Credit

I have seen many young people who could not qualify for a home loan because they had two auto
loans.  If you cannot afford to pay cash for a car, keep the payment low. 

There is "smart" debt.  If you take out student loans and get through medical school that is smart debt.  If you buy a car that you need to get to work or use for work that is smart debt.

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