Are You on the Express Lane to Debt?

There are always plenty of articles and commentary written about rapacious lenders and banks taking advantage of the “little guy” by giving him too much credit too easily and then when most inconvenient for the borrower they hit him with higher interest rates or some other financial disadvantage. I’m not about to defend big banks but like any “addict - pusher” relationship you can’t have one without the other.

Credit cards and charge cards are our most common type of short term credit. Frequently we use the terms credit card and charge card interchangeably but they are actually quite different. Keep on reading to see if you were aware of these very important distinctions.

Credit Card

A credit card is issued by a financial company and gives the holder an option to borrow funds, usually at the point of sale. What this means is that you are essentially financing your purchases at a pre-set borrowing rate determined by your credit rating or the whim of the issuer/bank.

Credit cards have higher interest rates than most consumer loans or lines of credit. Some credit cards rates are now approaching 30% and my advice to you is charge only what you can comfortably pay off each month on your credit cards in order to avoid these high interest rates and running the risk of completely destroying your credit rating if you fall behind.

Every store and gas station welcomes payment through credit cards making them one of the most popular forms of payment for consumer goods and services in the US whether the card holder can afford to make the payments or not.

One important note is credit cards differ from a debit card, with which money is automatically deducted from the bank account of the cardholder to pay for the goods or services. This is true even though many debit cards have a credit card affiliation such as Visa or Master Card.

Did you know that credit card use originated in the U.S. in the 1920s?

Early credit cards were issued by various firms (e.g., oil companies and hotel chains) for use at their outlets only. Diners’ Club issued the first universal credit card, which was accepted by a variety of establishments, in 1950.

Charge Card

Charge cards such as American Express require cardholders to pay for all purchases at the end of the billing period (usually monthly). While charge cards are similar to credit cards, the major benefit offered by a charge card is that it has a much higher, often unlimited, spending limit. However, if the balance is not paid when due, cardholders can incur large penalties and do terrific damage to their credit rating.

Let’s examine for a moment when we use credit or charge cards. If we are not paying for all purchases with cash or debit cards we are using some form of credit. The use of credit can be for business purposes to purchase supplies, services, or some other business necessity such as travel or entertainment. It can be for personal use such as an emergency at your home; your car breaks down on the highway, or, as is far too often the case, you use it to purchase non-critical but desirable consumer items. Starbucks comes immediately to mind. That is not to say I don’t enjoy my Starbucks but cash is the best option for these types of purchases. Financing a $4 cup of coffee simply does not make good financial sense.

Clearly the road to financial problems is to finance the mundane and small items that make up our day. If you are whipping out a credit card to buy a cup of coffee, to gas your vehicle, to purchase groceries or clothing, then you are literally financing your way into a high interest debt that simply does not make sense. If you are not paying off these small purchases each month, the bill will continue to grow ever larger and that “cute” pair of jeans you bought on sale will wind up costing you a LOT more money than if you had stopped to think about whether your budget could stand that purchase and you had just paid cash instead.

So why do we make these purchases? For one thing unlike generations from the early and middle part of the 1900’s we have the capability via TV, the Web, and other types of media to see what we are “missing”. We are able to see the luxuries of the rich and famous all day every day.

To make matters worse with credit we can purchase some of the “good life” on credit. By overrating (or even worse, not thinking about it at the point of purchase) your ability to pay for the item or items you just financed may be greatly diminished with time and ever increasing interest rates and penalties.

Lesson to learn - don’t buy on credit except in an emergency.

Instead go on a cash basis or near cash. Next, be realistic and not overly optimistic on your ability to repay debt you accumulate in order to justify a purchase. Stay tuned for the next stop on the express lane to debt .

© 2010 Theodore Henderson