Tuesday, February 26, 2008

What Got You Into Credit Card Debt?

From what I can gather, credit card users fall into two main categories:
  • Those who use credit cards as a tool: they pay off balances every month and collect rewards, or use low APR offers to make money, and they like the organizing features of credit cards that can simplify finances.
  • Those who use credit cards as a crutch: they carry a balance and pay interest because, for one reason or another, they were unable to have access to personal cash when they needed/wanted it.
What are the folks in this second category putting on their credit cards? I am really curious. Sometimes I am just appalled at the number of people who are deep in credit card debt and I just can't understand how they could let it get to that point. I am tempted to assume that they spend on "frivolous" things. Am I right? Am I wrong?

The absolute foundation of personal finance is to spend less than you earn. If you spend more than you earn, then you're in debt. If you spend as much as you earn, then you're fine until something unpredictable happens, and then you're in debt. If you spend less than you earn, you will probably be ok unless you get hit by a serious emergency.

So, what's behind these huge credit card balances? Here's what I've been able to figure out:

I can understand the following expenses, although I do think almost all of them can be prevented.
  • Healthcare costs: If a big chunk of your credit card debt is on hospital bills etc., then you were either going without insurance or were under-insured. My cousin recently had a crisis situation with her toddler needing neurosurgery after a fall while they were in the middle of a move, two weeks before their new plan kicked in. Yikes! They set up a payment plan with the hospital and the miscellaneous health care professionals. No credit card needed.
  • Living expenses when you've lost your job: This is why an emergency fund is so important. If my emergency fund was still small and I lost my job, I would be out there picking up hours even at minimum wage to make ends meet while I hunted for a better job.
  • An unexpected home or auto repair: Yep, two words: "emergency fund"

Now, I don't understand why one would carry a balance for the following:
  • Wants: electronics, gifts, books, dining out, travel
  • Standard living expenses: groceries, utilities, phone, car insurance, clothing
Both these categories, wants and standard living expenses, should be paid for by your income. These are things that can be planned for. If you want them and there isn't enough money coming in, earn more money. If you're putting these items on your credit card and paying interest, then there is a fundamental flaw in your understanding of income. Credit cards are not income.

So I want to know, when the media talks about the huge credit card debt statistics, what category are they referring to? The people who are using credit cards as a tool? Those who are using it as a crutch to get through tough emergency situations? Or those who simply don't know how to manage their money enough to not spend more than they earn?

Any ideas?

(In case you were wondering, my credit card debt is all at 0% and will be paid off before I have to pay interest. I used it for doing some home improvements when I purchased my house. I have always had the money to pay it all off if I chose to do so.)


Trihardist said...

I got a credit card in college to pay for my books (because it was more sensible than charging it to my school account, at the time). As college progressed and my scholarships, loans, and part-time job income weren't enough to feed me, I used my credit card for everyday needs, primarily groceries and toiletries. I got into triathlon senior year and used my credit card to pay for a $300 bike (all my other equipment was paid for out of pocket; the only reason I put the bike on the credit card was because I found an excellent deal--a $500 bike for $300).

Of course, now that I'm out of school, I think, "Stupid! Stupid! Stupid!" I wish I would never have gotten a stupid credit card. Since graduation, I've been shunting as much money as possible each month in three directions: emergency fund, general savings fund (I'm upgrading my bike; it's a work expense), and debt repayment.

I just got my car back from the mechanic; he replaced a head gasket. It cost $1500, which wipes out my emergency fund, with the remainder on the credit card. I felt like I was just starting to get ahead: I was building savings, repaying debt, starting to think about making some investments . . . then I have to fix my car and it feels like I'm a square back from square one.

So that's my story with credit card debt. I think it's just really difficult to make up for poor choices once one realizes the error of one's ways.

Erika said...

How do you feel about pay day loans? My husband recently lost his job and I'm worried about making ends meet on my salary until his new job starts to pay. I'm concerned about borrowing money at all but I found this website http://www.nationalpayday.com/ that offers free pay day loans and does not require a credit check. I've never taken a pay day loan before but it seems like it might be enough to keep us going. Any thoughts?

moneychallenge said...

Erika, I have never used payday loans and I don't think they're a good idea. In fact, I think they're a BAD idea if you're trying to close a gap between your income and expenses.

If I were in your situation I'd try to find an hourly job for the evenings and weekends that pays weekly or more often. I'd use that money to cover the gap until the husband's regular paycheck kicks in.

I'd also call my creditors and ask for an arrangement to decrease my minimum payments for a while. And of course, I would seriously cut down on any discretionary spending (including groceries, entertainment, subscriptions etc).

I don't know your exact numbers or where you're spending money so I can't assume this will work... but that's where I would look for a solution.