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I love credit cards. They provide safety for online and offline purchases, pay me cash back, and make paying bills so much easier.
However I’m not blind. I know there are problems with credit cards. I just think the problems are from financial ignorance rather than the “evilness” of megacorporations.
Three Main Problems with Credit Cards
The main problems people have with credit cards come from the individual misusing the card:
- charging an amount and not paying in full at the end of the month, resulting in finance charges
- buying depreciating assets
- spending more than they can afford in general so that minimum payments are taking over the budget
I’m going to hit on the depreciating assets point today.
This is one of the most serious problems with credit cards misuse. Using credit isn’t necessarily a bad thing. I use credit all of the time, never carry a balance, and have yet to pay interested on any credit card account. Also consider the mortgage on your home. This is credit that is being extended to you, yet no one seems to think it is a bad idea (unless your mortgage is an interest-only sub-prime disaster waiting to happen mortgage). In real estate — for the most part — credit is a good thing. How else could anyone afford a $175,000 home?
What is a depreciating asset?
A depreciating asset is something that you buy that decreases in value over the length of ownership. For example, you buy a new car for $30,000. The instant you drive off the lot the car is “used” and worth only $26,000. You’ve just experienced a depreciation of $4,000 real dollars. If you tried to turn around and sell the car that very moment you would experience a loss.
Another example would be a plasma TV. You bought a 46″ plasma in the fall of 2007 for $1,900. The TV is now worth $1,200… and has depreciated $700. Selling the TV results in a financial loss.
A majority of the things we buy are depreciating assets. Most clothes, electronics, and cars depreciate in value. Admittedly, some of these things do increase in value, but rarely (think classic cars from the 1960s) and when they do it is usually in hindsight that the best deals are found.
The biggest mistake we can make when buying a depreciating asset is to throw interest on top of the costs were are facing. If you are already losing money on the television mentioned above, it hurts you even more when you pay $300 in interest because you bought the TV on credit. Instead of a $700 loss, you’re really taking a $1,000 loss due to the financing charges.
Look at the things sitting around your home. Did you finance any of them? Are they worth more or less today than when you bought them?
A look around our living room: sofa, TV, stereo system, lamps… all are most likely worth less than when they were first purchased. And that’s okay — some of it in inevitable. But if your house is stacked to the brim with piles of stuff that are only going to be worth less tomorrow than they are today, and you’re paying interest to own them… that’s when the problems kick in.
Buying appreciating assets on credit is a completely different story. We’ll cover that tomorrow.
4 Comments, Comment or Ping
MyMoneyAdventure
The key to financial success is limiting buying liabilities. Some people just don’t get this.
May 20th, 2008
jamal
ok so according to this most of the stuff we buy on credit cards are depreciating asset. If a majority of the things we buy are depreciating then according to this we shouldnt be using credit cards at all. I dont get it….I guess for me it all about the value of your investment. If i use my plasma tv for 5 years then yes i am willing to take that $300 finance charge hit till i pay it off. However if im using that tv for only 6 months thats a different story.
May 26th, 2008
Lo. Price
I think this oversimplifies the matter a little. If you really think about it, you break even when you buy on credit and the appreciation rate of the asset is equal to the interest rate you pay minus the cost of inflation (not taking into account transaction costs). Theoretically, if you can buy everything on credit with a lower interest rate than your salary increase, you are coming out ahead, regardless of appreciation or depreciation. The problem of course is that most credit cards charge double-digit interest, and even people who take advantage of short-term lower rates end up paying double-digit rates eventually. My point is that it is hard to argue that simply buying depreciating assets on credit cards is a bad idea (therefore arguing that buying appreciating assets on credit cards is a fine idea). If you want a simple mantra, just don’t ever carry a balance on credit cards.
Jun 4th, 2008
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