Wednesday, January 9, 2008

Credit Cards: Necessary Evil or Unnecessary?

I see a lot of people writing about how much they despise credit cards. How they will never use them again once they’re paid off. There's been some discussion in the pf world about this lately, starting with Lynnae, then got picked up in debate by MyDollarPlan and Ana at Debtfree-Revolution (which has a wealth of links to other bloggers writing on this topic).

My response to cutting up your credit cards is: Whoa!

I know that some people have problems with credit cards, but cutting up the cards is not the answer! The answer lies in altering your behavior about money and credit. If someone can’t control their use of a credit card, they’re not likely to be able to manage with cash much better – though they will have a built-in ‘stop’ point with cash.

There have been articles and books about the psychology of money, and they are worth visiting or re-visiting. I’ve not read any such books, personally, though my mother highly praises what she read in Suze Orman’s The 9 Steps to Financial Freedom: Practical and Spiritual Steps So You Can Stop Worrying. While I hate the shame/blame tack she takes towards women’s finances (I cringed mightily when I saw her TV show about this), I do like her strategies for discovering the type of money personality you have. My mother, who after living on cash while she was raising me and only got credit cards well after I left home, read Orman’s book and realized some crucial ideas about where her views on money, and money management, came from, and it helped her.

Let’s look at a few hypothetical examples: you’ve just paid off your debt, sliced your credit cards, and then your mother/dear aunt/brother who lives across the country is suddenly dead. You only have $500 in your emergency fund, you have no credit card, and the last-minute plane ticket to get to the funeral costs $1000. What do you do?

What about your car? Most people I know that have to pay for car repairs end up paying between $1-2k. What do you do if it’s winter and you can’t close your passenger window, and you need your car to get to work (e.g. good bus service not available) or you, in fact, need your car to do your work?

What about your house? I live in Seattle, and a year ago there were some massive, massive storms, and many people had to do partial or complete re-roofing of their houses, or repairs because of floods. This is a definitely a necessity and something that can't be put off. If you own a house, what do you do if this happens? If the water heater fails? If your septic tank cracks?

Credit cards serve a very useful function. They can provide little loans for when you don’t have the cash on hand. I’ve used credit cards when I’ve inadvertently not had my debit card with me, and was somewhere like the grocery store (and when I got home I would immediately transfer that amount to my credit card), when I’ve been places without a cash machine that wasn’t with my bank (so I could save on the fees). A couple times when I’ve been travelling, I’ve been in cities where I couldn’t find an ATM that would accept my debit card (though the first time that happened, I was able to get a cash advance on my debit card, without that bank or my bank assessing a fee for that service – which I consider very lucky). A recent example of this for me is this: yesterday, I went to the dentist and because I haven’t been working much lately, I was very hesitant to use money in my savings account to pay the bill. So, I used my credit card (instead of paying in installments). Because I paid the balance in full yesterday, I got a discount of about $70. That is a far larger savings than I will either pay in interest, or if I had opted for the installment option [and paid using my debit card], and I also have a greater piece of mind in not taking that money from my savings.

If you use credit cards “Because I deserve to have this mp3 player/dress/vacation/whatever” then yes, you have a problem. That problem is not the credit card – it’s how you use the credit card. There is a very, very big difference between the credit card and the use of the credit card. All too often, I see personal finance writers (and blog commenters) blame the credit card as the problem. I can’t stress how much I disagree.

I have a girlfriend who has an airline credit card, and she uses it as often as she can, and then pays it off in full each month. She uses the card to get frequent flyer miles and free upgrades and airline tickets. What she does is very smart, and she uses the credit card as a tool to get something she wants (flight upgrades and free airline tickets).

Personally, I use my two credit cards for low balance transfer rates, so I can pay my principal down quicker.

To be sure, credit card companies prey on people who have issues with money. I don’t disagree, and neither do I approve of this. However, this is how it is and changing that is not my fight to fight. Part of smartly using a credit card is understanding its terms. My fight to fight is to (hopefully) provide some kind of wisdom [based on my personal experience and those of the people who’ve shared theirs with me] so that others can benefit. To that end, I want to reiterate: the credit card is not the problem.

If someone uses credit cards “because they don’t make enough to live the life [I] want” they will never make enough for that. I do believe it’s a good idea to know what you need to make, to ensure all your bills are paid, your retirement account is fully funded, and also to have enough left over to live a reasonable life. Earning enough to live a reasonable life is a valid, healthy goal. The trick is, though, when you get to that point that you don’t adjust your standard of living so much that you start living outside your means…and then have to count on getting a raise ‘just to get by.’ One thing I’m very thankful for, is that since I’ve been earning more money [per hour] than I ever have before, I’ve maintained the lifestyle I had when I earned less [aka frugality]. I’m not saying I make a lot of money. I didn’t make as much as I thought I would last year, and it wasn’t too different overall from my hi-tech days, though I did have a lot more free time (which is important to me), and I live well below my means (my cost of living is less than my hi-tech days). Yes, I know I’m single and without kids, and that factor is significant for me and my situation.

But I’m digressing a bit. The point is this: if you don’t learn to manage how to use credit for the tool it is, you will never be fully comfortable with money. I actually think it’s a very good thing for young people to rack up some debt, so they can have a better appreciation of money and to also learn the lesson and importance of budgeting.

Credit cards are only a trap if you allow them to be. Imagine if you worked in a cookie shop (which I did, once). Is it the fault of the cookies if you constantly eat them and gain weight? Or is it the fault of you not having enough self-control to not eat six (or more) cookies every shift? Is food the fault for someone being overweight? Budgeting and money management is a lot like dieting: the right balance needs to be found and self-control must be exerted.

There are no easy fixes to learning how to successfully and continually manage how credit cards can and should be used. It is, however, possible -- just like learning to live within your means or on a budget. It just takes time and self-control.


lynnae @ said...

Thanks for this post. I know we don't see eye to eye, but this was very informative.

I should reiterate that I don't see credit cards themselves as a problem, and I completely agree with you that people need to change their behavior, or their money problems won't be solved, regardless of whether or not they cut up the cards.

I do think that credit card companies can be ruthless and predatory, and that's what I have a problem with.

As for emergencies, I will cross that bridge when I come to it. There used to be a time and place before credit cards in this country, and people managed to deal with their emergencies without financing them. Yes it was hard, but they managed, and that's what I plan to do. Right now I think that's best for my life. And it sounds like you're making a good decision for your life.

I really enjoyed this post. :)

Debt Free Revolution said...

First of all, Madison and I had planned to do the credit card debate before Lynnae had her situation with Citibank. As I said, I have nothing against the actual pieces of plastic, but let's face it, the companies behind the credit cards are NOT your friends. I have much more important things to do in my life than to vigilantly watch over a credit card company, then continuously call their version of "customer service" to get mistakes straightened out.

As for emergencies, I have an emergency fund of over $1600 currently, and once the truck note is paid off this spring I will be upping that to $11,000. That should cover just about everything, including replacing my central-heat-air unit. (knock on wood)

Shana said...

Lynnae: I completely understand how you feel about credit card companies. Thankfully, I've not experienced any weirdness (like you have with Citibank) ever.

I do understand that you didn't cut up your cards because you saw them as a problem. That that point became how I started the article just happened... Though I have seen a lot of other writers write along the "credit card=problem" point of view, and I've known people who believe the same thing. So, I think the other things I've read, and your post, just blossomed up into this.

Debt Free Revolution: I agree with you, too, that credit card companies are ruthless. Like I mentioned already, I've been lucky enough to not have anything hassle-intensive happen with mine. My point with the emergency fund is that it seems like some people destroy their cards as soon as they're paid off and before they have a reasonable amount [for their/their families needs] set aside. I don't plan on getting rid of my cards in the future, though that also has to do with my travelling, and the security and options they provide when I'm on the road.

Thanks for your comments!