No Debt Plan

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‘ve said it before in the past, I’m not afraid of using a credit card.

A quick run down of the benefits of using a credit card and paying off the balance every month:

• Purchase protection both online and offline
• Fraud protection both online and offline (if your card is stolen and you report it, you owe usually at most $50)
• It makes budgeting easier by reducing the number of places you send a bill. I charge almost all of our utilities to a credit card, then pay off the credit card. This also saves me on postage.

Granted there are risks. If you carry a balance, that’s just silly. Paying an annual fee is also silly.

I haven’t discussed this in the past, but there are lots of different places you can find a credit card. You can go to each provider’s website (AMEX, Chase, etc.) and look at the options. But you can’t compare across sites, at least not easily.

At All about credit, you can do just that. It’s a huge database with different credit cards. You can pick and choose to decide which one is best.

(Photo by terren in Virginia)

Yesterday I told you not to buy depreciating assets on credit. Today I’ll share my thoughts on buying appreciating assets on credit.

For starters, let’s get some definitions hammered out.

What is an appreciating asset, and what do you mean by credit?

An appreciating asset is anything that increases with value over time after you buy it. If you bought a Picaso painting for $2 million and three years later it is worth $4 million, the asset has appreciated (gone up) in value. The picture above is a sculpture in Chicago. I’m guessing it might go up in value over time, making it an appreciating asset.

For this post I’m not going to focus on just credit cards when I say credit. Why? Well, usually you aren’t going to be buying appreciating assets on a credit card because credit limits are not very high compared to most appreciating asset costs. There are exceptions to every rule, of course. You might be able to buy some antique glassware on a credit card that ends up appreciating. However, for the most part an appreciating asset is going to be something big like a house or classic car.

Additionally credit card rates are generally too high to overcome to earn a significant return. If you’re being charged 15-30% interest, the asset would have to appreciate extremely quickly (and very high) for it to be worth using a credit card.

Why Buying a House on Credit is a Good Thing

The most obvious reason credit for large items like a house is overall very positive is the simple fact that very few people could afford to purchase homes up front with cash only. Home owners tend to be more stable and feel more control over their lives than when living in an apartment complex.

Getting people into homes is great and all, but isn’t the main benefit of using credit (a mortgage) to purchase a residence. Up until the recent housing frenzy and bust, homes generally have appreciated over time. And with mortgage rates being extremely low (5.5-6.5% for a 30 year fixed rate)… and the government giving a tax break on mortgage interest… then it makes a lot of sense to own a home.

Now I will say I am not a fan of “investing” in your house. You buy a home to live in it, not to profit from it. I don’t want to tie up my retirement plan in my home. As we have seen with the recent housing bust, that can make your wealth disappear overnight.

But watching the house appreciate over time is a nice bonus, especially since the money you received is very cheap. Today’s mortgage payment of $1,000 will over time become cheaper and cheaper to the home owner because of inflation. With a payment that costs you less in real dollars over time, plus the added bonus of even slight appreciation, home ownership is a good deal.

The Bottom Line

If you can be absolutely certain that the asset you are buying is going to increase in value by a specific amount, you can easily run the math to see if borrowing money to purchase today is a good idea. For example if I can be guaranteed that an asset I buy today for $10,000 will be worth $20,000 in one month’s time, I can afford a very high interest rate if I were to borrow the full $10,000.

If you cannot be certain or guaranteed the value will increase, you can still consider buying on credit. A home is a good example. Home prices in our area may not go up meaningfully in the next few years. We may not see a solid return on our money “invested” in the house. But over time, I can be fairly certain our house will be worth more than it is today.

The main problem people run into is they purchase assets on credit that are virtually guaranteed to go down in value. Buying a new car with 100% financing is an easy way to make sure you will lose money on the deal… every time. So not only should you try to change your behavior and only buy appreciating assets on credit, you need to avoid buying assets that are guaranteed to depreciate when you buy them.

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.

Thanks to our American Express Blue Cash Card, we’ve earned $327 in cash back so far this card year. The card year is dependent on when you signed up for the card, so ours runs August-July. Last year we earned over $430 just by using our card as we would a debit card.

This is why I believe in credit cards. They are a tool. They can be misused.

We don’t pay an annual fee. We don’t carry a balance. And we get cash back from 1-5%.

But you tell me… would you like to have essentially a free $327?

I think we all would. Feel free to correct me.

I’m a big fan of credit cards. That’s been hashed out here before. I love getting paid for my normal shopping habits. I love my AMEX Blue Cash rewards. I love how I am protected if the card is stolen. No one is emptying my bank account tonight; at least not because of my credit card (I wouldn’t get this protection from my debit card.)

Yet there is one thing that just baffles me: why pay an annual fee?

Credit card companies offer two different types of cards. The first requires you to pay to use the card on an annual basis. These fees can range from $29 to more than $99. Of course the second type of card lets you use it without charging an annual fee. There are a multitude of no annual fee cards available. So why pay an annual fee?

I haven’t heard a solid argument yet. So drop the annual fee card and pick up a credit card (to use wisely) with a great rewards program.

These are some cards I would recommend. They carry no annual fee and have a decent rewards program:

AMEX Blue Cash (My personal favorite because you can earn up to 5% cash back. I think cash is better than any of the other rewards because you can spend it on hotels, air fares, or whatever else you want.)

Discover (Very similar rewards to AMEX Blue Cash.)

AMEX Clear (Blue Cash has a better rewards program)

AMEX Blue Sky (if you prefer your rewards for flying)

Chase Free Cash (1% cash back)

So there are some options for you. Stop paying an annual fee and enjoy some rewards to boot. I know American Express also has some very low balance transfer fees in the range of 4.99% to 5.99%. Transfer some of your high credit card debt, pay it off, and then chalk up the rewards.

We use our credit cards for every purchase that we possibly can. As I’ve said in the past, credit cards are not evil.

We got several mailers today from American Express encouraging us to spend our money with them. One was showing off a new tool they have for Blue Cash users that lets you track how much money you have spent on the card. This is important for the Blue Cash because rewards are based off one of two tiers. The more you spend, the higher the cash back percentage. The new tool is called the Cash Back Tracker.

The Good

The Cash Back Tracker is actually a pretty nice tool. You can track how much you’ve spent and earned for the current year, as well as what you earned last year in rewards.

As you can see from the image, we’ve earned $279 in cash back thus far this year on $16,819 worth of spending. That comes out to 1.66% overall cash back. In comparison, we earned $432.15 year ending July 2007. That was a big year — we got married and charged everything associated with it and our honeymoon.

The Bad

Unfortunately, AMEX wants to encourage me to spend even more money with them in the hopes I will carry a balance they can charge interest on. To that end, they let you set a rewards goal for the year. I could let them know I want to earn $500 in cash back. To earn that, of course, I’ve got to spend, spend, spend. This may seem innocent enough because it could be used just to show me what I’ve got to spend to get to that goal. I just don’t think it is too innocent.

Conclusion

The important piece for us is we are earning a couple of hundred dollars each year for free. We pay off the balance every month, and in turn get rewarded for it. Some others, like Free Money Finance, are earning more than 2% from multiple cards. We’re content with what we are currently earning because it keeps it simple. We don’t juggle ten different cards to get the highest return. I love paying our utilities with the card to earn a return on money I would have spent regardless. Sounds like a win-win to me. The tracker is quite handy because I can see how much we are earning in an up to date format.

As always, be careful. Don’t go spending just to earn a small percentage back in rewards. Use your credit card like a debit card.

Many of you will disagree with this sentiment, but hear me out.

Credit card companies do not generally have your best interests in mind. They want you to charge as much as possible, and take your time paying off the balance. A $10,000 credit card balance, at a 14% interest rate, with a $125/month payment will take you 229 months to pay off. That is more than 19 years. Oof!

As cash hungry as those credit card companies are, they do not pay evil henchmen to run around the United States and hold guns to consumers’ heads. Debt that is racked up on credit cards is voluntary. You picked up the card. You went to the store. You swiped it at the register. Take some personal responsibility.

Granted, the card companies try to appeal to every one of your impulses to get you to use the card. “It’s easy!” “You can pay it off later!” “Come on, it’s just this one time…” Mailer after mailer ends up at your house, full of pre-approved offers. They see it as trying to win your business. We all know they are trying to entice you into a never ending cycle.

Despite all of this, I love our two credit cards. Here’s why.

• A credit card is a tool. Other controversial items — guns, for example — have the same stigma. The credit card does not charge purchases on its own. A gun does not pull the trigger. Both are risky tools. With risk, comes responsibility. Used wisely, credit cards are a beneficial tool to have in your wallet. (For the record, I am not a fan of guns, and do not own one. I know the risk, and have made the choice against it. Credit cards can be viewed the same way. Nor am I saying they are on the same level — just making a comparison here.)
• Rewards. From August 2006 to July 2007, I earned $432 in cash back rewards with my American Express Blue Cash card. Some will argue that the risk is not worth the reward; I’ll tackle this in a future post. Yet, I’m not going to argue when I earn $400+ for simply paying my bills as I would normally.
• Purchase Protection. There are always catches, but for the most part anything I charge on my AMEX is covered. If someone on eBay rips me off, I don’t pay a dime. I use the card heavily (i.e. I make them a lot of money), so most small charges can simply become a write off for the card company. I have only had to use this protection once when I ordered a gift for my Mom from an online store that never shipped it out.
• No interest paid. We pay off the statement balance at the end of every month. Result? I’ve never paid interest on my cards. We use the cards just like they were cash.
• I don’t spend more than I would otherwise. This is the real kicker, even for people who pay off the balance at the end of every month. The common rant against credit cards is you typically charge 12-18% more than you would if you paid cash. We simply don’t do this thanks to our budget. More on budgeting later, but if you truly stick to the budget it is not possible for you to spend more than you would otherwise.
• One Payment. Well, a handful of payments. As I mentioned, we use our credit cards for almost everything including utilities, car and life insurance, groceries, and eating out. Rather than having to write a lot of checks during the month, all of those payments get bundled into two cards.
• Safer than a debit card. Some (Dave Ramsey) argue that debit cards are better than credit cards because you can’t spend more than what is in your account. This is true. If you simply can’t control your spending, don’t get a credit card. If you can, the credit card is a better option. If your debit card is stolen, all of your cash is at risk. You may get it back, but it can take a while for the bank to get everything sorted. If your credit card is stolen, your risk is limited to whatever stipulation is in your agreement. I think a common agreement is you pay nothing after the first $50 of unauthorized charges.
• Delayed Payment. This is a heavily marketed “benefit” of credit cards to consumers. Charge now, get the item now, but pay later. We always have the cash on hand to pay the bill, but get to hang on to it for a while. Thanks to ING (savings and checking), we earn at least 0.25-0.33% on those purchases each month. (3% on checking/12 = 0.25, 4% on savings/12= 0.33%). It isn’t much, but every little bit counts.

Do you use credit cards? Do you carry a balance? Do you get rewards? I am only a fan of cash back cards. Airline miles are only good on airlines. You can use cash on anything.