On Credit Card Addiction And Ignoring The Points!

wallet_hub_credit_card_debt
Source: WalletHub

Congratulations, America, we did it! We finally broke the $1 trillion barrier for household credit card balances, according to a recent WalletHub Report.

This is a somewhat less impressive than Roger Bannister’s breaking of the 4-minute mile barrier in 1954 (RIP Sir Roger, B. March1929 — D. March 2018), or Sir Edmund Hillary and Nepalese sherpa Tenzing Norgay’s shared ascent of Mount Everest in 1953. Unlike those incredible human achievements, we all did this one together. $1 trillion! When you think of how far we’ve come, there’s practically nothing we can’t accomplish when we all work together!

I bet you did your part. The average household’s credit card balance hit $8,600 – also an all-time high according to WalletHub.

The previous high point in US credit card household debt was the final quarter of 2008, just at the moment in the Great Recession when it all came crashing down. I’m not linking those data points through causation, I’m just mentioning interesting facts you might want to know.

I’m teaching a personal finance course this semester at Trinity University in San Antonio, and in the course of the discussion recently on personal debt and credit scores, one student asked a very good question:

What’s the best credit card for a graduating college senior to get?

She hopes to have a decent income soon and she wanted to start building up credit. Should she shop for the miles or the points? Should she worry more about balance limits or the interest rate? And which banks offer the best terms? I could tell from the reaction in the room that many students wondered the same thing.

roger_bannister
RIP Sir Roger

Well. A mild rant ensued.

My answer, which I’m only somewhat happy with, involved trying to debunk the myth of “smart consumers” who maximize their mileage points or rewards programs, or who shop for the lowest rates on credit cards.

A low or teaser interest rate should be totally irrelevant, I said, because you shouldn’t carry a balance month to month. Don’t focus on the interest rate. Focus only on not carrying a credit card balance.

And the points and miles? These, I further ranted, are all tricks. All of them. They are equivalent to the tickets you win from playing games at Chuck-E-Cheese that allow you to accumulate enough to buy a plastic ring at the end of the birthday party. (Sadly, now you know how I spend my Saturdays.)

Yes, I admitted, I also benefit from travel miles and rewards points, and I also have a variety of credit cards in my wallet. To the extent psychologically possible, however, I try to ignore the various tricks and distracting “points” I’m earning.

edmund_hillary_tenzing_norgay
A fine bromance: Hillary & Norgay

Another student in the back row raised his hand. What about a credit card that offered 10X the rewards points, he wanted to know. Surely that would be worthwhile?

No. Stop. You are being tricked. There is no savvy points-maximizing strategy I can endorse.

I understand there are websites dedicated to all the different supposedly clever strategies around this stuff. For that matter there are many websites dedicated to people who dress up their pet hedgehogs in funny outfits – does that mean it’s a worthwhile activity? (Apologies to my 8 year-old who is obsessed with hedgehogs and recently pointed out these websites to me.)

The point is this: the best personal financial behavior tries as hard as possible to ignore the credit card marketing of points and rewards. Savvy consumerism doesn’t involve trying to maximize these things. The credit card companies are not dummies. The marketing wings of the credit card companies know, in fact, that we are the dummies.  The credit card companies will get back from us much more than they pay out with their Chuck-E-Cheese tokens.

Anyway, that was my rant at the time.

But I wasn’t totally happy with my answer.

I’ve thought about “what’s a good credit card?” more since then and want to add a few thoughts I didn’t say that day in class.

reese's_addictionBecause not only are there no good credit cards, the question itself feels wrong to me. It makes me cringe in all my sensitive finance places. I think of the question as the equivalent of asking a nutritionist what the best candy bars are for a college student. Or asking a substance abuse counselor what the very best narcotics would be for a graduating senior to take.

They are all bad choices. Some could be less bad than others, but it’s really not the product itself that could be intrinsically good, or advisable. No responsible financial advisor, nutritionist, or drug abuse counselor should endorse any of these things.

Instead, the responsible counselor can merely advice around moderating or eliminating behavior in the use of those bad products.  Yes, we can imagine consumers of credit, candy, and cocaine as fine people, enhancing their life or engaging in guilty pleasures in responsible ways.

credit_cardPersonally, I use credit cards because they are incredibly convenient. Fortunately for my family, I don’t abuse them. Our household balance is not part of the $1 trillion American problem.

And yes, I have been known to abuse Reese’s Peanut Butter Cups, in those stupid King-Sized 4-paks. Just sitting there, taunting me in the checkout line at the grocery store. It’s terrible, I know, but preferable to cocaine. I won’t judge you if you won’t judge me.

But make no mistake: Debt is a drug. We’ve never been more addicted than we are now. And many of us desperately need help.

 

A version of this ran in the San Antonio Express-News and Houston Chronicle.

Please see related posts:

What’s in Your Wallet? Hope

Why You Hate Your Bank

 

 

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Ranking of Credit-Card Indebted Cities Explained

My wife, who spent her formative years in College Station TX, asked me “why don’t Aggies eat barbecue beans?” Answer: “Because they keep falling through the holes in the grill.”

That’s not nice at all! And, most likely, not even true! Although I can’t be sure because I’ve only visited College Station myself a few times.

Aggie jokes popped into my mind because CardHub.com, an online aggregator of credit card information, published a mildly interesting report this past week ranking US cities in terms of their average expected time to pay off credit card debt.

college_stationThe Ranking
Aggies, brace yourselves. College Station ranked 2,547 out of 2,547 cities. That’s dead last in the entire country in terms of capacity to pay off credit card balances in a timely way. Ugh.

It got me thinking about how the home of a distinguised research institution would have the ignominious distinction of being last in the country in terms of credit card debt sustainability.

By contrast, CardHub lists the city with the #1 ranked fastest time-to-payoff credit card debt as Cupertino, CA.

Methodology
CardHub’s method for rankings went as follows. They figured out average income per household in each of 2,547 cities, according to the US Census, as well as the average credit card balance in each city, as provided by credit bureau TransUnion.
CardHub assumed a 14% annual percentage rate on balances – and then assumed an affordable payment of existing balances each month, adjusted for average income in the city.

Using that data, CardHub calculated how many months – on average – it would take the residents of a city to pay off their credit card debt.

I describe their report as only “mildly interesting” because while it purports to show something novel about average indebtedness by municipality, it’s actually an interesting example of how financial statistics may mislead and just reflect demographics.

Cupertino_CAIs it just wealth?
Cupertino, CA – the #1 ranked city in the CardHub study – is an address which you may recognize as the home of Apple, the world’s most valuable company.

Of the top 10 cities ranked by time-to-payoff – all but one are in tech-rich California cities or affluent suburban-Boston cities of Massachusetts such as Lexington or Arlington. Of the top 30 cities, many others are recognizably wealthy suburbs, including Bloomfield Hills, MI, McLean, VA, and Chevy Chase, MD.

So I guess one way to look at these rankings is just to notice that residents of high-income and wealthy cities can pay off their debts more easily while residents of poorer cities – by definition – will take longer to pay off their debts. That’s sort of obvious, and also not very funny at all.

Another Aggie joke
But did you hear the one about the Aggie who won the Texas lottery but was told he’d have to receive the money in 20 yearly installments instead of a lump sum? He was so angry! “In that case,” he said, “just give me my dollar back!”

Ok, that isn’t nice at all, either. Also, seriously, you should never play the lottery.

Or another factor?
Besides the high income and wealth factor, which I think is sort of obvious (and again, not that funny) I was wracking my brain to figure out how a college town in Texas ranks dead last nationwide in terms of time-to-pay-off credit card debt.

The best I came up with is that a plurality of the population of College Station, TX is actually students – who naturally earn practically nothing – but who do incur credit card debt in the ordinary course of their studies.

I’m pretty sure my theory is correct. According to the US Census the median age of a College Station resident is 22.3 years, compared to the median age in the United States of 37.2. Furthermore, the population of College Station in 2010 was about 94,000, while Texas A&M reported a student population that year of about 49,000. So I think what CardHub’s time-to-payoff credit card rankings really highlight – at least at the bottom – is a population of students, in their debt-incurring phase of life, rather than their earnings phase of life.

College Students
Supporting my theory about the preponderance of a student population of a city is the fact that other cities ranking in the bottom of CardHub’s list of 2,547 include other college towns like San Marcos, TX (#2,532 and the home of Texas State University) and Provo, UT (#2,531 and the home of Brigham Young University).

So, I’ve come to believe, Aggies and College Station TX can’t be razzed for ranking dead last in the country on this measure. It’s just a demographic anomaly of a student-dominated city population. I spoke to Jill Gonzalez, an analyst at CardHub, who seconded my analysis, and named for me some other prominent college towns that ended up on the bottom of the list.

donut_seedsA third Aggie joke
Meanwhile, my father-in-law, a long-time Texas A&M professor and Aggie booster, sent me a link to Aggie jokes online, and I appreciated the one about what Aggies think Cheerios are: Donut seeds.
I like that one. Personally, I will never see Cheerios the same way again.

The actual point
Ok, the (semi) serious point of looking at a financial ranking like “time to payoff credit card debt” is that statistical financial rankings like this can often obscure reality. CardHub’s ranking of cities may be interpreted as a demographic ranking of wealthy cities at the top and college towns at the bottom.

Very likely the Aggies of College Station, TX aren’t worse at handling credit card debt than the rest of the country. They’re just students who haven’t begun to register any income yet.

Still, it’s tempting to make a make a few jokes, no? I’ll probably be run out of town for this post.

 

Editors Note: To avoid hate-mail from Texas A&M boosters, I’ve decided to remain anonymous, except for the fact that a version of this ran in the San Antonio Express News.

 

 

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FICO Part II – When To Ignore It, And Why Its Awesome

fico_scoresLast week I wrote about the personal credit score, used by virtually all lenders in this country, known as FICO.

But I know there are some of you who you can and should ignore your FICO score.

I also want to mention the risk of paying too much for your score, the benefits of boosting your score, and a reason why I think FICO is kind of awesome.

Maybe disregard all this?

I made the case that everybody should spend up to $20 to buy their FICO score (and credit report).

But personal finance guru Dave Ramsey makes the following fine point about FICO scores: Ignore them.

That’s fine for his larger lesson, which is to urge people to live entirely debt-free. If you live a cash-only, debt-free financial life, you don’t need a FICO score because you don’t ever need to ask a bank for a loan.

For people at the extreme ends of the financial spectrum, I endorse Ramsey’s hard-core approach to FICO scores and borrowing.

If you can always pay cash because you’ve got unlimited amounts of it, by all means ignore your FICO score. And if you’ve been in distress because of a debt problem that needed curing through bankruptcy or by going cold turkey on borrowing, again I think Ramsey’s right. Ignore your FICO score.

But for the 90 percent of us in the middle, we need to pay attention to our score.

When you know your score before you walk into a bank, you know whether the loan you got offered by the bank is at the lowest rate possible.

If you don’t know your own FICO score, you’re entirely at the mercy of your lender.

Call me crazy, but maybe you don’t want to do that?

What else NOT to do

While I do think we should spend a small amount of money to learn our FICO score, I want to caution people about the FICO-purchasing process.

Do not spend too much money on this. Achieving the right balance of FICO knowledge means not overdoing it. Each of the three credit bureaus, plus the Fair Isaac Corp., will try to encourage you (“trick you” is maybe too strong a word, but that’s basically what they’re doing in my opinion) to sign up for “monthly credit monitoring,” for something like $25 per month or $120 a year.

Don’t do this.

Also, all these folks will offer a “free” credit report and score, as long as you make a long-term (read: expensive) commitment to buy more of their services later.

Again, don’t do this.

Having been through the experience a few times, I will warn you that they make it relatively difficult to simply purchase one credit score from one bureau for under $20, but that simple purchase and price should be your goal.

And it is doable.

Benefits of FICO repair

What’s clear from the FICO formula is this: If you have unpaid bills, taxes, judgments or liens weighing down your credit score, you can turn around your credit score.

Not without settling up with creditors on what you owe, and certainly not quickly, but it can be done. Consider it a marathon, not a sprint. And if you can survive the marathon, you’ll reap considerable rewards.

On your car, with a 720 FICO qualifying you for a prime loan, you might lower your loan’s interest rate by 10 percentage points. On a $20,000 loan over seven years, you’d pay about $100 less per month with a prime loan instead of a subprime loan, or about $8,575 less in interest over the life of your auto loan.

On your home, the differences are much more dramatic still. With a 720 minimum FICO, you might lower your mortgage by 5 percentage points, moving from a subprime to a prime mortgage. On a $200,000 mortgage over 30 years, you’d end up paying $655 less per month, or $236,000 less in total interest over the life of your mortgage.

Even more, a low credit score could lock you out of the chance at homeownership entirely, which might have even more dramatic financial results given the advantages of homeownership.

That’s why small changes in solving past credit problems can lead to big financial results in the long run.

No discrimination

Besides the financial advantage of knowing whether you qualify for a prime loan, I’m a big fan of the FICO score because of its essential “fairness.”

In a way, FICO scores are awesome — because they do not discriminate based on anything about us except our own past borrowing behavior.

I’m not certain the George Bailey “It’s a Wonderful Life” world of banking ever existed — where a banker could personally decide to lend, or not, based on judgments about a customer’s reputation and character. If it did exist, we can imagine that discrimination played an important part of lending decisions.

A FICO score however, does not discriminate based on income, wealth, profession, geography, education level, race, class, gender, sexual orientation, physical ability or the three timeless banker’s questions posed by the Zombies back in 1967: “What’s your name? Who’s your daddy? Is he rich like me?”

When you think about it that way, FICO does something amazing that none of us can do, since we are all (hopefully unwillingly) bundles of human discrimination at all waking moments.

Sylvester_McMonkey_McBean

Yes, a FICO score reduces our glorious individuality into a dehumanized series of digits, to be fed into a banking conglomerate’s Sylvester McMonkey McBean machine and spit out the other side. But, if you understand this dehumanization as the opposite of discrimination in lending practices, you might decide that’s actually a good thing.

 

A version of this post ran in San Antonio Express News

Please see related posts

FICO Part I – What goes into the scoring?

Ask an Ex-Banker: Monthly balances and FICO scoring

 

 

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Ask An Ex-Banker: FICOs Score and Monthly Balances

credit_cardsNote: See Part I on FICO Scores, which inspired this question from a reader.

Dear Banker,

I’ve been getting copies of my 3 credit reports annually since 2005.

I’m concerned about a change in the reported information from Capital One and Chase. My reports used to reflect
1) amount billed
2) scheduled (minimum) payment
3) actual payment

The latest reports from Transunion and Experian no longer reflect the “actual payment” amount, so although my reports show all payments made on time, it doesn’t reflect the full balance being paid monthly as opposed to the minimum payment.

I feel like I have to alternate credit cards in order to have a zero balance every other month so it doesn’t appear that I’m making minimum payments and carrying an unpaid balance.

I’ve contacted Capital One and Chase to ask them to report the actual payment amount as they used to, but all I get is a standard response “we’re correctly reporting your account” to the credit bureaus.

Am I wrong in thinking that if they report amounts in addition to whether or not the account is “paid on time”, they should include actual amount paid as well as amount billed?

Thank you
Bette in SA

credit_report

Dear Bette,

Thanks for reading, and for your good question.

The most important element for FICO scoring (35%) is whether bills are paid ‘on time,’ so if you’re consistently doing that, your score will reflect that, and the fact that there’s a balance on your report is (mostly) irrelevant.

The FICO algorithm doesn’t care whether you make minimum monthly payments or full-balance payments. As long as payments are being made ‘as agreed’ according to the fine print you signed with your credit card company, your FICO score can’t distinguish between people who carry a balance and people who pay off their balance every month. What I mean is your score won’t be hurt by minimum monthly payments, nor can you really boost your score by making maximum/full balance payments. There is (almost) no distinction between them, for scoring purposes.

Small caveat: One small part of your score reflects your ‘usage amount,’ meaning what proportion of your available credit balances are used at the time of the score. Meaning, if you had a total of $10,000 in available credit among all your cards, and you were using $9,750 of that with a credit card balance, that could slightly lower your score. Not much, but a little.
Conversely, If you had a total of $10,000 available credit, but only showed up with a monthly balance of say $300 (leaving you with $9,700 available unused credit), that would slightly raise your score. Not much, but a little.

credit_score_auto_loans
A useful graphic linking credit scores and auto-loan rates

That would be the only sense you could be concerned about the monthly reported balance as you described. However, if you have many thousands in available credit and only hundreds in reported balances, those reported balances are basically irrelevant for your score.

As for you question to Chase and Capital One – I’m sure they won’t change their reporting methods. They just do an automated snapshot on a monthly basis to send to the credit bureaus. On any given day of that snapshot, we (the consumer) may have an outstanding balance on our card, even if we don’t carry any balance month-to-month.

My strong advice – don’t try to alternate card usage, and don’t worry about it, it’s not hurting your credit.

Michael

 

Please see related Posts

FICO Part I – What’s in the Score?

FICO Part II – Ignoring FICO and also why FICO is awesome

 

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Square’s Small Business Lending – Innovative?

square_capital_lending_to_small_businessA friend sent me a link this morning to an article about Square Capital’s small business cash advance business. The credit card processing company Square claims to use credit card receipts data to prompt it to advance money – within as quickly as 24 hours from the request – to existing small business customers, even before they ask.

My first reaction, of course, is that we should beware banks bearing gifts of “easy, fast” money. That’s the style of pay-day lenders and its never a good thing. I have received more than my fair share of business credit card solicitations in the mail, with high interest and hidden fees, to remain skeptical of this kind of innovation.

On the other hand, Square Capital’s money seemingly comes with

1. A 10% fixed fee (high, but a reasonable annual rate when it comes to small businesses);

2. Flexible payment terms. Merchants are expected to pay on their own time frame, out of ongoing credit card receivables;

3. No paperwork or waiting, which is pretty rare in the small business lending space.

For a certain type of high-growth small business customer, I can imagine the appeal of the Square Capital offer.

Although the article in Wired emphasizes the innovative aspect of Square’s use of Big Data to identify potential customers for their cash advance, the core of what they’re doing is really a version of “factoring,” the oldest type of commercial lending in the world. Instead of purchasing future receivables at a discount, Square will simply ‘factor’ the receivables by charging an extra 10% fee on top of the amount of repayment. While traditional factoring, or nouveau factoring like Square Capital isn’t particularly new, it can fill business’ need for fast money at a time of high growth.

Small businesses without deep pockets often have few choices about where to raise capital.

There’s the most expensive way: Selling equity to friends and relatives.

Then there’s the next most expensive way: High-interest credit card debt.

And then there’s the least expensive, but slow way: Apply for, and receive, a traditional bank loan.  This rarely works.

I have claimed in the past (and still basically believe) that, despite their rhetoric, the vast majority of banks are not in the small business lending business at all.  Banks would prefer to lend against real estate or cars because both types of loans can be offloaded from their balance sheet through securitization. All other types of loans have been effectively replaced by personal or business credit cards.

To the extent Square Capital can update an old lending model – factoring – with a new data-rich approach to get small businesses money quickly, the innovation sounds worth knowing about.

 

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Some Terrible Financial Advice: The “Emergency Fund”

sacred_cowIf you frequently read articles, books and blog posts about personal finance – as is my unfortunate wont – you quickly stumble upon one of the sacred cows of the genre: “The Emergency Fund.”

“The Emergency Fund,” the grown-ups tell us (as in this post that showed up in my inbox yesterday,) consists of 3 to 6 months of wages, socked away in a safe CD or savings account at the bank, untouched by regular expenses. Only when you stumble to the emergency room for your uninsured, unplanned, uninvited $5,000 appendectomy, or only when you lose your job and take 6 months to land a new one, are you allowed to dip into this account.

This sacred cow of personal finance, however, deserves to be cow-tipped at midnight. Because, mostly, its a complete load of bullcrap.

I’m not saying it’s a bad idea to have some ready money in the bank. Of course it is a good idea. Money in the bank is lovely. The idea is fine. But it stinks as a piece of personal finance advice.

In reality, there are three types of people, and none of these three types need the ‘Emergency Fund’ sacred cow advice.

Group One – You have money in the bank, (or stocks in the market, or a trust fund annuity, or whatever) without having been told. Maybe you were a fortunate beneficiary of the genetic lottery and tax code (The first $5.5 million inherited is tax free!), or maybe you just have a squirrel-like capacity for storing nuts. Good for you, but you really don’t need to be told about the Emergency Fund rule. The advice is irrelevant. You’re past that, you got that covered.

Group Two – On the edge of solvency, trying to make it through every month with all bills paid, but occasionally slipping into deficit. This includes about 50% of all Americans and 90% of Americans under the age of 30. This is the group to whom the “Emergency Fund advice” gets directed by the concerned grown-ups with a furrowed brow.

Now, this Group Two might, theoretically, be interested in the advice, but it really doesn’t even make financially savvy sense to follow it.

Here’s the mathematics of why. If you’re at break-even financially, with occasional monthly deficits, then you’ve got some credit card debt. You’re like 55% of Americans who carry a balance from month to month. You might pay the national average of 12% on that credit card principal balance. If you’ve got a checkered pay history you’re looking at 18% to 29% interest on the balance.

emergency_fund

To make the math easy, let’s assume you have $5,000 in credit card debt, on which you pay 15% per year in interest, which totals $750 per year in interest.

Ok, now let’s say you somehow, despite paying significant interest on your debt burden, manage to accumulate a $5,000 Emergency Fund, just like they told you to. Congratulations. Now the adults convince you to ‘do the right thing’ and put it in an untouchable savings account.

Here’s some more easy math: You can safely earn up to1% annually on that Emergency Savings, or $50 per year.

So, in sum, the sacred cow advice is to pay $750 per year in interest while earning $50 in interest? Let’s just lock in a $700 loss per year! So even for this group, to whom the advice always gets passed, it doesn’t make sense.

What makes financial sense for Group Two, instead, is to have close to zero savings, but also to have close to zero credit card debt, with open lines of credit to be drawn on in an emergency. In that scenario, you neither earn interest nor pay interest, and you’re certainly not safe and comfortable, but at least you don’t lock in an annual $700 loss on your money, due to bad advice.

Because let’s face it: If you’re in Group Two, the choice isn’t between having an Emergency Fund or not. The choice is between having high-interest debt on the one hand and low-interest savings account on the other while paying the difference to your bank(s), or having neither and keeping the money yourself.

In a related story, nobody in Group Two actually has an Emergency Fund.

Group Three – Totally indebted, with no prospect of savings. This includes the chronic under- or unemployed, anyone whose house is in foreclosure, or is bankrupt, or not paying their credit card bills. At any point in time this is going to include about 25% of all Americans.

Yes, an Emergency Fund would be fabulous, but it’s totally irrelevant for this group.

I know I’m being flip and overly simplistic about this, and for the five readers who are about to write in to tell me about their emergency fund and what a great thing it has been for them, I apologize in advance.

You know who really likes the ‘Emergency Fund’ advice? Those five people. The ones who already have one.

You know who else really likes the ‘Emergency Fund’ advice? Banks, because they can earn the interest rate spread between your debt and your savings.

But for the 299,999,995 other people who have done the math on the classic Emergency Fund advice and agree with me: Respect.

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