Managing Credit

Lecture "Managing Credit"

Discussion Question:  Filing Bankruptcy 

Assignment "Personal Debt Management"

Self-Assessment

Personal Finance

Banking, Credit Cards and Debt

By Dr. Mark Skousen, Grantham University

“A great deal of freedom is lost when you have to spend the present paying off the past.”

                                                            -Harry Browne

Credit and debt are fine if you can pay for them in the short range, which is defined as three month for this purpose. Carrying a debt obligation for longer periods of time takes away your ability to afford to systematically save and invest. Once long-term debt begins to accumulate, it like investments, takes on a life of its own and snowballs, making debt reduction very difficult and stress provoking. Later in the course we will discuss the idea of establishing a pay cash account as part of your overall financial program. This gives you the ability to meet unforeseen emergencies and impulse buy when it makes sense.

Overall, banks and finance companies (who issue credit cards) can be a great source of help but also a headache. They can provide you with the convenience of paying for goods and services every day, with a checkbook or bank card, but they can also make credit so easy you get into trouble, and maybe even be forced to declare bankruptcy. 

Going into debt isn’t necessary bad, and may provide many benefits to enjoying a higher standard of living before you have the means to pay for it with cash. But it also can be playing with fire if you allow it to be abused and overused. 

We asked one hundred people what they would do if they suddenly received $1,000. Over one third replied, “pay off some debts.” Consumer debt is one of the most serious financial threats facing Americans today. For many people the debt/salary ratio is so high that they must work several months out of the year just to pay for clothing, cars, vacations, appliances, medical care, and other goods that they have already used up during previous years. It’s no wonder that most people find it so hard to get ahead. Like the federal government, many people struggle just to keep up with the minimum payment requirement, and have no real hope of ever paying off the balance of their debts. 

And it’s not getting any easier with convenient stores now allowing customers to use credit cards to buy food and drinks. 

Yet, it is interesting to note that one fourth of the people we polled had no debts at all. And many of these debt-free citizens earned less than $50,000 a year.  

How do middle-class citizens let themselves become so overextended? 

The primary cause is the easy availability of credit -- from credit cards to overdraft privileges to mortgages. Of course, by credit they actually mean debt. It’s interesting how Madison Avenue changes the meaning of words: 

“Save -- half off” actually means spending at a discounted price.

Credit cards are actually debt cards. All these new terms are meant to put a positive twist on negative terms. 

Your Credit Report

A credit report is a tool to determine whether or not a person deserves to have some or more credit. As such it should be managed like any other valuable financial tool. Wise consumers should check their credit reports at least annually and make sure it is accurate and that other peoples’ information has not mistakenly found its way into your report. If there are issues the main providers of these report will insert something called a “creditor communicator” into the report which provides you an opportunity to tell your side of the story. This is very valuable and available without cost to all Americans. This is especially important because there is an increasing trend among employers to do a credit check on you before a hiring decision is made in positions involving trust and responsibility, and for those of you who might be in the military services it will certainly be part of the investigative process involved with the granting of security clearances.

How is your credit rating -- your history of paying your bills?

It might surprise you to see what it what it says in your credit report. It’s worth finding, because often the credit reporting agencies have their facts wrong. 

Actions to Control Your Credit

What to do to get control of your debts and credit card abuse?

First, use only a debit card or cash at convenient, grocery or drug stores.

Credit cards should never be used for consumables, period. And be sure to keep track of all items bought with a debit card, as instructed in Week 1. 

You should also seriously consider avoiding credit cards for the purchase of consumer goods in general. It’s a mistake to finance a television, stereo, designer clothing, vacations, and other high-priced items on credit, hoping to pay off the loans with future paychecks. Students and newlywed couples moving away from home for the first time often make this mistake. Faced with the prospect of furnishing and stocking a new home or apartment, they begin using words like “investment” and “saving in the long run” to justify purchasing new, top-quality items rather than shopping for used goods at garage sales, or doing without for awhile until they can afford to pay cash. Thus, they start out with poor financial habits, and continue living beyond their means through consumer debt until they are inundated with bills they can’t pay.

Investment writer Douglas R. Casey has said it well, “Disposable consumer goods like clothes, furniture, and vacations have little or no value to others, so it’s almost always a mistake to buy them on credit.” 

Second, if you have a problem abusing credit cards, consider tearing up your credit cards

Replace them with charge cards (such as American Express, which requires payment in full each month), or just plain cash and checkbook, for making purchases. 

Sometimes the only way to stop abusing your credit cards is to get rid of them, and use substitutes: debit cards, checkbooks, or cash. 

This extreme measure reminds me of a story of Jon Golding, a financial counselor and friend who advised wealthy clients in England who had gotten into financial trouble. His standard procedure would be to invite the husband and wife into his office, ask for their credit cards, and without their permission, tear them up right then and there. They were shocked but finally recognized that the credit cards were the source of their trouble. It wasn’t long before they were on the road to recovery, and they thanked him for tearing up their credit cards.

Third, make it a game to pay off your debts. 

Another long-time friend and financial guru, the late Harry Browne, tells how he got out of debt at an amazing pace. He related the following story in his book “How I Found Freedom in an Unfree World”: 

“How I Got Out of Debt”

By Harry Browne

I’ve never liked debt. I’ve had plenty of it and I dislike the way it immobilizes. To me, freedom includes the opportunity to spend money as I choose, to spend it at the time I receive it. 

When I was much younger, I was once so deep in debt that I thought it was foolish to even think I’d ever be out of it. I don’t believe in bankruptcy, so I thought I was stuck for life.

One day I totaled all my obligations and found that I owed $13,000. Because I was making very little money at the time, the amount seemed so enormous that I thought it was pointless to pay $50 or $100 against it. 

But I also began to feel that there wasn’t anything more important to me than getting rid of it. I resolved to try to reduce it by some amount during the next couple of months. If the effort were to make my life too miserable, I could always go back to my old spending habits; but for two months I’d concentrate on the task. 

I kept a running total of my debts and reduced the total every time I made a payment against it. At the end of the first month, I’d lowered it by only $400. That meant it would take over two years to liquidate the whole amount.

But it was fun to see the total go down. Before long, no purchase was as exciting as buying a position of less debt. I was inspired to take on extra jobs -- because every fee I earned meant a reduction of the total. 

If it became necessary to replace a household item, I did it in the cheapest possible way -- knowing I could always improve upon it later. For now, cutting the debt was my most compelling motivation. 

Once a momentum was created, the debt shrank faster and faster. Finally, I was totally out of debt -- seven months after I’d believed it would be impossible to ever get out of debt. I happily gave up the austerity budget and went out and splurged on new clothes, dinners, and dates (paying cash, of course). 

What I did isn’t necessary what you will do -- possibly it would be more difficult for you. But I cite the experience as an example of how wrong it can be to think there is no way out. There’s always a way out -- once you made up your mind as to what is most important to you. 

If it’s important to you to be debt-free, then work extra hours, cut out nonessential spending for a while, or sell items you don’t need. Find a way to put yourself in a position you’d like to be in. If you know why you’re doing it, and it’s important to you to do it, you won’t mind the temporary austerity.”

From Harry Browne, How I Found Freedom in an Unfree World (2004), pp. 208-209. Reprinted by permission. 

Filing for Bankruptcy: The Hidden Danger

The tips above can help you avoid future debt, but what if it is already too late for you? What if you are so deeply in debt that you see no way out? Should you file bankruptcy, as the law allows, and give yourself a fresh start? 

Personal bankruptcy should always be a last resort.

It is a legal process where you surrender some or most of your assets. In the United States, you can file personal bankruptcy (chapter 7) on your own or with an attorney. In Canada, personal bankruptcy is filed through a licensed trustee. 

The advantage to filing bankruptcy is that most of your debts are discharged. But there are many disadvantages:

You may lose some of your assets, such as your car (a home is exempt in some states, such as Florida and Texas, if it is your primary residence). 

Your credit rating will suffer, and you may not be able to obtain credit for many years. A bankruptcy can stay on your credit report as long as 10 years under federal law. Items discharged in bankruptcy would normally only stay on your credit report for 7 years even though they have zero balances. 

There is often a moral stigma attached to bankruptcy. 

Fortunately, there are many alternatives to bankruptcy:

Use your own means and budget to repay your debts.

(See the Harry Browne story above.)

Seek credit counseling involving debt consolidation. 

This is a great way to reduce your outstanding debts and interest payments. It often involves wage earner plans, where you might have a certain amount automatically withheld from your paycheck or checking account to repay debts. But be sure to shop around. Some credit finance companies charge extremely high interest rates to consolidate loans, sometimes as high as 24%. Credit unions may be a better alternative. 

This is a good reason to find a solid financial advisor. If they are experienced and practical they can help you avoid such situations in the first place and guide you through the options if you are already in trouble. Often they possess a network of trusted practitioners in a variety of fields and can refer you to the person who is in the best position to provide you the help you require.

For more information, go to Focus Website Marketing, Inc., US Bankruptcy Information at http://www.bankruptcy-america.com/

by cutting and pasting this link into your browser.

I’ve known a number of friends in businesses who have filed for personal and business bankruptcy. They are so heavily in debt that they see no alternative but to start over. 

However, my favorite story about bankruptcy is about my long-time friend and financial writer, the late John A. Pugsley, author of “Common Sense Economics” and “The Alpha Strategy.” Jack (as his friends called him) produced “Investment Expo in Los Angeles” in 1980 and invited dozens of speakers, including me. Unfortunately, the conference did poorly, despite the number of high-profile speakers, and he lost half a million dollars. He rejected filing for bankruptcy on ethical grounds, and instead, went to the speakers and begged them to give him a year or two to pay them. Every speaker agreed to the postponement except one (a well-known bleeding-heart liberal economist who sued him).

Two long years later, Jack has finally earned enough money to pay off every one of his creditors. In a world today where bankruptcy in business is common, I take my hat off to Jack Pugsley for his integrity.