Start Late, Finish Rich, page 6
THE CREDIT CARD INDUSTRY HAS
A SECRET YOU NEED TO KNOW
In order to fully understand the secret the credit card companies don’t want you to know, you need to understand a little about the credit card industry and its history. So let’s take a look.
HOW THE CREDIT CARD CAME TO BE
Back in the 1950s, when the modern credit card industry began, things were different. The pioneering credit card companies like Diners Club and American Express expected customers to pay off their balances in full within 30 to 60 days, and because of that only people with excellent credit (like successful businessmen) could get a Diners or Amex card. As a result, in those days, having a credit card was a major status symbol. If you had a credit card, you were cool!
By 1960, banks had begun offering what were known as revolving credit cards, which permitted users to stretch out the payments if they wished. The first and most successful of these was Bank of America’s Bank Americard. Initially, you could get a Bank Americard only in California. But in 1965, Bank of America hooked up with a number of other banks around the country, and Bank Americard became the nation’s first national bank credit card. Two years later, a competing group of banks introduced the MasterCharge program, and by 1969 virtually every bank in the country was issuing either Bank Americards or MasterCharge cards. It was still cool to have a credit card, but it wasn’t as special as it used to be.
In 1977, with the credit card business growing ever more global, Bank Americard changed its name to Visa. Two years later, MasterCharge renamed itself MasterCard. But the real change in the business went much deeper than just a bunch of new names. Whereas Diners, Amex, and the other old-line card companies made most of their money from membership fees and sales commissions, the newer bank cards generated most of their revenue from interest charges. Since banks were now running the business, this wasn’t really surprising. Charging interest on borrowed money is how banks make money. So why should their credit card business be any different?
This change in the business had huge implications for consumers. For one thing, credit cards suddenly became incredibly easy to get. Having a credit card no longer made you cool (unless, of course, you had a gold card, later replaced by the platinum card, and now by the black card). Students could get them, kids could get them—even dead people and pets occasionally wound up getting them.
But the change had another, much more important impact on consumers. Suddenly, the credit card companies began doing everything they could to encourage customers to carry balances. Minimum payments were lowered, incentives were offered, grace periods were shortened.
What accounted for this shift? Unlike the old-style companies, which get very annoyed if you don’t pay off your bill each month, the banks that issue Visa and MasterCard credit cards want you to take your time. In fact, the longer you take, the happier they are. Why? Because the longer you take, the more interest you must pay, and the more money the bank makes. They’re happier still when you’re late with a payment, because then they can charge you a late fee on top of the interest, which makes them even more money.
HERE’S THE CREDIT CARD INDUSTRY’S SECRET
The secret of the modern credit card industry is that many banks don’t really need you to pay off your debt. Their profits go up if you only make “minimum payments.” And they’re smart enough to know that if they ratchet the minimum payment down low enough, you’ll keep spending money and they can make a fortune on you.
Not surprisingly, they don’t want you to understand this. They don’t want you to know that if you borrow $10,000 on your credit cards and pay only the minimum payment with an interest rate of 19.98%, it will take you more than 37 years to get out of debt—and before you do, you will have forked over nearly $19,000 in interest charges.
HERE’S ANOTHER SECRET
THEY DON’T WANT YOU TO KNOW
The credit card companies want you to be late because there’s big money in collecting late fees. Not only can they charge you penalties as high as $39 a month if you’re even one day late, they can also hike your interest rate. According to Robert Hammer of R. K. Hammer Investment Bankers, a California credit card advisory firm, the credit card industry earned an estimated $13 billion from late fees and other penalties in 2004. “You’ve got more fees, charged to more people, triggered more quickly than ever before,” Hammer warned.
One woman I recently helped with a money makeover was hit with $295 in late fees in just one month—and her average interest rate was raised to 29%! Her credit card companies love her! And she’s more typical than you’d think.
The credit card companies have figured out how to move your due dates around, shrink your payment time from 30 days to as little at 21 days, and generally keep you confused enough to ensure that you’ll be late paying—as a result of which they can “get you.” It’s a great business—and the credit card companies are winning. It’s also a numbers game, which is why the industry reportedly mails more than a billion credit card offers each year to homes across America.
AND NOW THE RETAILERS
WANT IN ON THE GAME
Of course, it’s not just the banks and the credit card companies. These days most big retail chains that offer charge cards do so in conjunction with a bank (or similar financial institution). Why does a store like Banana Republic or the Gap push you so hard to get one of their credit cards? You thought these guys were in business to sell clothes, didn’t you? Well, if they can get you to buy your clothes on credit—and if you don’t pay off your balance right away—they can make a lot more money.
See if this sounds familiar to you:
You’ve gone shopping at the local outlet of a national clothing chain and you’ve picked out $1,100 worth of new clothing. (I know this sounds like a lot of money. I’m just using it as an example to make the math easier.) You’re at the register, about to write a check for your purchase, when the cashier, a nice, chipper, good-looking young person, smiles at you and asks, “Wouldn’t you like to save 10% on your purchase today? You know, instead of writing that check, you could save $100 by opening one of our charge accounts. It will only take a minute.”
A typical shopper, trying to be smart, will think, “Good deal—I save $110! Let’s do it!”
Cut to a month later, when the bill arrives. “Total balance,” it says, “$990.” “Oh, man,” you say to yourself, “I totally forgot about that.” But then you see a much smaller figure next to it. “Minimum payment due: $24.75.”
“Now, that’s more like it!” you think—and instead of paying off that painful $990 balance, you make the painless $24.75 minimum payment.
That’s exactly what the store hopes will happen. And according to a 2004 study by the Cambridge Consumer Credit Index, it’s in fact what nearly half of all Americans do each month when they get their credit card bills.
YOU CAN’T GET OUT OF DEBT
PAYING THE MINIMUMS
What’s so bad, you ask, about paying less rather than more? The answer is nothing. But if you’re trying to deal with your credit card bills by paying the minimum amount due, you’re not paying less. You’re paying more—a lot more. If your interest rate is a typical 18% and you make only the minimum payment each month on a $990 charge, it will take you 152 payments—or nearly 13 years—to pay off the balance due. By then, the clothes you bought will be long gone—and because of all the interest you’ve had to pay, your $1,000 purchase will have cost you more than $2,100.
Not such a good deal, is it? Well, not for you. For the store, it’s a great deal.
Again, $1,000 might sound like a ton of clothes. Don’t get hung up on that. I’m just using clothing as an example. You could just as easily go to the local big-box hardware retailer right now and finance a new lawn mower or dishwasher or large-screen television. It’s all the same game—and in most cases, you lose and they win when you take out a new credit card.
BORROW MONEY TO MAKE MONEY,
NOT TO LOSE IT
As of 2004, the average household credit card debt of people who carry balances (that is, typical credit card users who don’t pay off their bills in full each month) was roughly $12,000. If you pay just the minimum due each month on a $12,000 credit balance, you will wind up having to make 400 monthly payments before it goes to zero. That’s 33 years and four months’ worth of payments. And that’s assuming you never charge another dime on the card, never get hit with a late charge, and are never billed for an annual service fee.
Take a guess how much it will end up costing you to pay off that $12,000 balance on a credit card that charges 18% interest if you pay only the minimum each month.
The answer is $29,616! And that’s for a card that charges 18% annual interest. Many cards charge much higher rates—some as high as 29%.
The conclusion this should lead you to is simple: You can’t finish rich if you’re carrying credit card debt.
Think of debt as a trap that forces you to work longer than you should have to. What puts you into debt are bad habits like running up big balances on your credit cards and then paying them down slowly, if at all. You can be hurt and held down by habits like these, or you can take action to break them.
Here’s a simple rule to follow: The only time borrowing makes sense is when you do it to buy something that can go up in value, like a house—and even then, you want to pay off the loan as soon as possible.
IF YOU CAN’T PAY FOR IT IN CASH,
DON’T BUY IT
There’s an old commonsense saying: “If you don’t have cash, don’t buy it.” Hello! That’s a pretty darn simple saying that works really well. You only want to borrow to get rich. You don’t want to borrow to look rich! You don’t want to lease your lifestyle. If you are borrowing to look rich, you are guaranteed to stay poor. Really. No joke.
Think about what you bought with your credit cards recently. Was it a need or a want? Be honest. In order for us to get you out of debt (assuming you’re in debt), we have to get you to STOP.
IF YOU’RE IN A HOLE, STOP DIGGING
One more bit of preaching and then we’ll jump into the technical “how to” part of getting out of debt. Here it is: If you are in a hole, stop digging.
It’s time to cool it with the credit cards.
If this means putting a spending limit on yourself, do it. If it means vowing never to spend more than $100 at any store on anything that you didn’t go in already intending to buy, do that. If it means forcing yourself to take a 48-hour “cooling-off period” before you spend $100 on an impulse purchase, do that! (This 48-hour time-out is an approach I discuss in Smart Women Finish Rich. It helped me stop being a compulsive shopper, because it forced me to go home and ask myself, “Do I really need this?” Once I really thought about it, I almost never went back to the store and purchased whatever it happened to be. Eventually, I stopped shopping all the time because it got to be boring!)
The fact is, it simply makes no sense these days to run up credit card debt. It’s not only too expensive; it’s also too dangerous. Do what I do now. Don’t run up any bills you can’t pay in full every month. Refuse to pay 18% interest for items that are perishable. As those figures I cited earlier make clear, carrying a credit card balance is not a smart investment.
Better yet, pay cash for all your purchases. If you come across an item that is too expensive for you to pay for in cash, don’t buy it. If you spend only cash, chances are you’ll spend less. Spending $200 on clothes seems like a much bigger deal when you’re handing over a stack of $20 bills, as opposed to just signing a charge slip.
So now we know what we don’t want to do with our credit cards. With that in mind, let’s take a look at what we do want to do with them.
KEY “START LATE” PRINCIPLES IN
CHAPTER FOUR
• Dealing with debt doesn’t mean putting the rest of your life on hold.
• Your real enemy isn’t the debt; it’s the interest.
• You can’t finish rich if you’re carrying credit card debt, and you’ll never get out of credit card debt if you make only the minimum payment.
• The easiest and most effective way to pay off your credit card balance is to get your credit card company to lower the interest rate it charges you.
• Don’t run up any bills you can’t pay in full every month.
* * *
FINISH RICH ACTION STEPS
Reviewing the principles we discussed in Chapter Four, here is what you should be doing right now so you can Start Late and Finish Rich. Check off each step as you accomplish it.
Decide to stop using credit cards to buy things you can’t afford to pay off in full the same month you purchase them.
Commit to making more than the minimum payment due.
Commit to always paying your credit card bill on time, every time, so you don’t get hit with late fees.
* * *
CHAPTER FIVE
MANIPULATE THE
CREDIT CARD
COMPANIES—
LEGALLY
When I was a kid in school, the teachers always used to tell me, “David, stop talking.” Maybe you got that growing up, too? Well, when it comes to credit card debt and starting late and finishing rich, it’s time to start talking.
The reality is that if you know what to say and how to say it, you can literally get the credit card companies to lower your interest rates and waive your annual fees or late fees.
How is this possible? Because the credit card companies need you! The credit card industry can’t operate without your business. The industry today is all about recruitment. It’s like the Army, except instead of saying, “Join Us—Be All You Can Be!” their message is . . .
JOIN US—SPEND ALL YOU CAN SPEND
In order to recruit you, the credit card industry is doing everything it can to make you believe that credit card companies exist to help you. They are your friends, and to prove it they offer all kinds of perks, bonus reward points, frequent-flyer points, college account rebate programs, and on and on.
Unfortunately, for people who are trying to start late and finish rich, credit card companies can be false friends. While their services can make your life easier and more convenient, if you don’t use them responsibly, you will end up getting deeper and deeper in debt at higher and higher interest rates.
Even the name of their product—the “credit card”—can mislead you. Credit is such a positive word. Here’s what you find when you look it up in Webster’s:
cred-it (kred’it), n. [Fr. crédit; It. credito; L. creditus, pp of credere, see CREED], 1. belief; confidence; trust; faith. 2. the quality of being credible or trustworthy. 3. the favorable estimate of a person’s character or reputation; good name. 4. praise or approval to which a person or thing is entitled: as, he deserves credit for telling the truth. 5. a person or thing bringing approval or honor: as, he is a credit to the team . . .
The dictionary goes on in this vein for a while. Credit means confidence, trust, praise, approval, good name—all terrific things. It’s not until you get all the way down into the fine print of the definition that Webster’s mentions that credit can also imply financial obligations and “one’s ability to meet payments when due.”
The point is that when we hear the word “credit,” most of us tend to think of good things, not obligations. And so, we think, a credit card must also be something good—a kind of ticket to the good life.
THEY SHOULD CALL THEM
LIABILITY CARDS
If they wanted to be honest with us, the banks and the credit card industry would call their cards something else. I think labeling them liability cards would be much more accurate. After all, what does a credit card do every time we use it? It incurs liabilities—that is, debts—that we have to finance and eventually pay off.
To be fair, credit card companies are no different from any other company in our free-enterprise system. They’ve been created to make money for their owners. In their case, they do this by providing credit to consumers like you and me. We pay for this credit in the form of interest charges. So obviously the more credit the credit card companies can get us to take on—and the higher the interest they can charge us—the more money they make.
The reality is that credit cards can be a great convenience if you use them responsibly. That’s the challenge—and the big “if.” What you need to know now is how to fix the problem that your “if” may have created.
YOU ARE NOT AT THE CREDIT CARD
COMPANIES’ MERCY
Fortunately, we are not totally at the mercy of the credit card companies. As I mentioned earlier, they have spent a fortune to get you as a customer. According to The Wall Street Journal, the credit card industry sent out 1.3 billion credit card applications in 2003. That’s a lot of direct mail, which cost them a lot of money. As a result, it makes much more economic sense for them to do what they can to keep you happy than to lose you to a competitor that’s offering a lower rate or a better deal. You just have to know how to negotiate with them.
CREDIT CARD COMPANIES
WANT YOUR BUSINESS
As we discussed in Chapter Four, the credit card business is an extremely competitive one. It is also highly regulated by the government. What this means is that rather than your being at their mercy, credit card companies can be at your mercy—if you know what you’re doing. The thing to keep in mind is that unless you’re a total deadbeat, the credit card companies want and need your business.
