Understanding credit cards for credit card control
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Credit cards were born to make retail transactions easier and safer. Once they were introduced buyers did not have to carry rolls of cash to go shopping any more. They didn’t have to fumble around writing checks anymore.
They didn’t have to produce identification to prove who they were and that there would be money in the account when the check was cleared by the vendor. For the vendor the credit card company was good for the amount charged as long as the card used was not on a list of invalid credit cards circulated by the issuers. Shopping became much more convenient for both parties.
It was great for business. The banks who issued the cards made lots of money on the interest on credit card balances because they charge the vendor a flat fee plus a 3% to 5% surcharge on all amounts paid to the vendor on credit cards. Vendors who accepted credit cards made more money because they had the most convenient tool in the market place.
The credit card industry has grown and has reached the point where there is a credit bubble. There is so much credit card debt that one of the most basic tenets of incurring debt has been forgotten. That is; how does Debt affect your Budget and your Balance sheet?
Credit cards and your Household Balance Sheet
Credit cards are almost always used for consumer purchases. That means that when you make a purchase on your credit cards you incur a liability on your balance sheet. You will not have purchased something that will be entered with a value on the asset side of your balance sheet. Your net worth decreases every time you buy an item with your credit card. The only way that situation is resolved is when you pay off that item from your cash flow. If you do not pay off that item and continue to charge other consumer items without paying off the balance on your credit card, you are then creating a liability that offsets gains or savings that you may be building on the asset side of your ledger. You may still be saving but your net worth may be standing still or getting smaller.
Credit cards and your Household Budget
Credit cards require that you make a minimum payment of 3% to 5% of the outstanding balance every month. This includes interest plus a small amount towards paying off the outstanding balance. If your outstanding balance grows, the amount of money to service that debt grows. It takes a bigger and bigger portion of your take home pay every month. Logic dictates that a larger and larger proportion of your take home pay will be going to pay interest if you continue to increase your outstanding debt. The size of the debt gets bigger so that servicing that portion of the outstanding balance takes a larger and larger portion of your take home pay to service.
Conclusion
What has been lost is the concept that when you loan money you need to know how someone is going to pay back the balance some day. Similarly, when you borrow you need to have a plan for how you will pay off the principal of the debt and when. Business transactions should always be a win/win scenario and so it is with credit cards. Both sides of a transaction should know that their budgets and balance sheets will be better for the long term.
At some time, the borrower has to engage in some financial therapy and pay off the outstanding balance on the credit card. If you sell an asset and pay off your credit card debt you balance sheet stay the same and you will free up cash flow on your budget. If you pay off the debt slowly and leave your assets alone you will feel some pain in your budget for awhile but your net worth will start growing again because you decrease your liabilities. If both your budget and your balance sheet are overwhelmed, you need to explore options that mean you will start over again. This can be a very unhappy time but it may be an opportunity. Engage in financial therapy and start over at the beginning. When you get back to using credit cards use them for convenience and to capitalize on savings offered. Always pay them on time and always have a plan to pay off the outstanding balance.
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