The Credit Card Death Spiral

Wealth Daily ^ | 05/14/09 | Ian Cooper

[CottonBall]

That makes sense now. Thanks for the explanation.

[CottonBall]

I know this list is advocating not using credit cards at all, but....for those of us that still do but not irresponsibly ;) - I wanted to let people know how to get their credit scores higher. I just found ours out since we're looking at buying another house and both are over 800. And I don't even work! We have one loan - on the old house - and that's it. So I thought I would have bad credit at least. But the lady at the lending institution said that 1) keeping low balances on credit cards and 2) paying them off each month is what got our credit scores so high. I never knew that. I just thought it was very convenient to use the CC instead of writing checks. And the 1-5% back on purchases adds up as well. I thought having any balance at all on the cards would be bad when qualifying for a loan, but I guess the credit rating institutions can tell if it ongoing credit or new credit each month.

So if anyone needs to increase their credit scores, here's a pretty easy way to do it. As long as you can pay it off each month, of course!

[CSM]

OK, first you admit to playing with snakes and then you promote that we worship the great FICO! I am now sentencing you to 40 lashes with a wet noodle!

[CottonBall]

OK, first you admit to playing with snakes and then you promote that we worship the great FICO!

Admit to? You're trying to make me sound guilty of something. I have used credit cards responsibly, never paid any interest or fees, and have gotten cash back from them. Along with the ease of use of not having to write checks or carry cash. Not everyone that uses cards runs up bills they can't pay.

And if you never need a loan or a new job, then the credit scores don't matter. But employers check those scores to see how responsible the potential employee is. And I personally wouldn't want a house paid off, even if I had the cash set aside for it. (Which we do). For various reasons.

If someone has less self-control when it comes to credit, then of course they need to limit themselves access to it. For the rest of us, we get to make choices based on our own personal fiscal responsibility.

I'm sorry you appear to find this threatening. I would, instead, think it is something to strive for.

[CSM]

Um, I was being a bit sarcastic. I was hoping that the “wet noodle” comment would have made that clear. I apologize for not being more clear.

[CottonBall]

It’s hard to pick up on sarcasm without a wink and a nod sometimes. Or a /s too. I thought you were 100% serious! Sorry about that.

[CSM]

No problem here. I do have to admit that your post did send chills up my spine.

;-)

[CottonBall]

Chills - wow. Sorry! How so?

[CottonBall]

Well, I was trying to do the opposite of giving people chills. I was trying to give some hope!

I had extremely bad credit years ago after a foreclosure. The market we were in crashed by over 50%, so we rented out my townhouse at a loss for years. And then I lost my job and we couldn’t afford to absorb the monthly loss any more.

In fact, I never ever checked my credit scores until just now because I knew they’d be awful. When we got a loan on a house, my husband always applied for it solo. I had no idea my own scores could come back up, especially without me having a job.

So, for those that have had some bad luck and/or made bad decisions, as I did - there is hope!

[CSM]

I have been so emersed in Dave’s “baby steps” that I am now completely averse to borrowing money. My goal is to now have a FICO score of 0 (zero) which is the indicator of not borrowing money. Currently my score is probably pretty good with all of the debt that I have paid off, so I could probably qualify for any loan out there.

However, this rough patch is teaching me that debt adds a lot of risk to one’s life. Hey, all foreclosures have one thing in common, 100% of the foreclosures have mortgages. So, my goal is to pay cash for everything and get my mortgage paid off ASAP. Then it is save cash, save, save, and save some more. This will allow me to have adequate cash on hand if the need ever arises to upgrade my house.

The “chills” for me are a result of the risk associated with debt of any kind. When people refer to FICO, I equate that with debt, therefore with risk, therefore a disturbance to my own peace of mind.

No problems tho’, if others like debt, I can still be their friend.

;-)

[CottonBall]

The “chills” for me are a result of the risk associated with debt of any kind.

That I can understand. Our society has gone the way of thinking that debt that is unsustainable is the norm. That is scary. When the personal savings rate is negative :0

No problems tho’, if others like debt, I can still be their friend.

Good to hear that! Although I don't consider myself in debt if my cash on hand matches or exceeds what I owe. As long as I can pay it off at any time, I have peace of mind. It's when debt exceeds the ability to pay it off that I would panic - like making just the minimum payment on a credit card. There was one time that I had looming debt from a Sears card because it was 0% interest for 6 months or something like that. Rather than take money out of a good paying savings acount (not recently, obviously!), I let it ride for 3 months. But - I was thinking about it a lot and finally just paid it off because owing that money from month to month really bothered me. So, I do understand what you're saying ;)

W/r mortgagas - I did have the same idea that paying it off is best at one time. And still would if I lived where I wanted to retire and die. But we've had 2 instances of a large market drop happen and a 2-3 year backlog of homes on the market happen. And all within 10 years of each other! I don't want to risk being in the position of having to sell a house under those conditions if we also had a job loss. I know it sounds bad to have an escape plan be a foreclosure or short sale, but....with losing hundreds of thousands of dollars as the alternative, I might consider it. Plus, we desperately need the deduction since taxes are confiscatory now. When we retire, we can control the tax we pay, so that'll be a different story. We're planning on having everything paid off then and will live on whatever keeps us in the 15% bracket ;)

[CSM]

“we desperately need the deduction since taxes are confiscatory now.”

That is usually the first response that I get from folks when I talk about paying my house off. The reality is that it is a terrible business model to send $10,000 to a bank so that I can avoid sending $3,000 to the government. However, if I truly have that principle and I pay my house off, then I am still free to send $10K to a charity and use that as the deduction.

[CottonBall]

It all depends on what tax brackets the people are in and everything. I’ve done the calculations and I’d rather pay the interest, get 50% back, and be able to use the cash for investments that pay more than the mortgage interest is.

For now.

It’s not a one-size-fits-all world.

[CSM]

I’m not sure I understand your numbers, so let me take another run with specifics. These are totally ficticous and rounded for ease.

2008 calendar year tax info with mortgage:
Mortgage interest paid = $10,000
Tax bracket at 50% = $5,000 refund
Invest at 10% (2x mortgage int. rate) = $500 return
Annual Gross Salary = $100,000
So, the net would be $100,000 - $10,000 mortg interest = $90,000 x 50% tax rate = $45,000 due in taxes. $90,000 - $45,00 tax bill = $45,000 income + $500 ROI = $45,500 net income

With no interest deduction it would be:
$100,000 x 50% tax rate = $50,000 due in taxes
$100,000 - $50,000 tax bill = $50,000 net income.

Yes, in my scenario I pay $5,000 more in taxes, however my net is improved by $4,500.

Obviously, I am of the KISS principle, that prevents me from making my life to complicated.

;-)

[CottonBall]

But the interest earned would actually be on the entire house value, not just the tax refund.

And in the upcoming world (potentially) of hyperinflation, I’d rather have money in silver, gold, and ammo and have a huge debt that I can pay back in tomorrow’s devalued dollars. Not the mention the scenario of having housing values crash and a job loss.

There’s reasons to have a house paid for and I won’t debrudge anyone their reasons for doing so. We have a cabin that is paid for because I wouldn’t mind living there forever. And will if TSHTF and we need to escape the city life.

It’s peace of mind. You get yours from being debt free. I get it from keeping some options open and if all turns out well for the ocuntry economically, then I can change those options yet again.

It’s not a one-size-fits-all decision. I see the positives for both and even some moderation and compromise.