July 6, 2011
A debt management "expert" who doesn't fully understand credit cards?
On June 28, Fox News published an article by Clarky Davis, whom is said to be a "debt management expert and spokesperson for CareOne Debt Relief Services."
Her article, titled "6 Mistakes to Avoid When Paying Off Debt", lists six "typical mistakes consumers make when paying off their debt" in an attempt to become debt free.
I was shocked to read her third tip!
Here it is:
A debt management "expert" who doesn't fully understand credit cards?
On June 28, Fox News published an article by Clarky Davis, whom is said to be a "debt management expert and spokesperson for CareOne Debt Relief Services."
Her article, titled "6 Mistakes to Avoid When Paying Off Debt", lists six "typical mistakes consumers make when paying off their debt" in an attempt to become debt free.
I was shocked to read her third tip!
Here it is:
"Making large monthly payments.
When
facing a large credit card balance, it’s tempting to make a big
payment each month in order to see a significant decrease in your debt.
However, your monthly payment needs to fit your budget so you can
accommodate your other necessary expenses. If not, you’ll end up
relying on your credit card to cover basic living expenses and you’ll be
stuck in the cycle of making payments while racking up more debt at
the same time. Always try to pay more than your monthly required
minimum payment – double it if your budget allows -- to begin making
immediate headway in paying down your debt."
Do you see the problems with her logic?
Do you see the problems with her logic?
Let's take a closer look:
1) "When
facing a large credit card balance, it’s tempting to make a big
payment each month in order to see a significant decrease in your debt.
However, your monthly payment needs to fit your budget so you can
accommodate your other necessary expenses."
It's true that your actions need to allow you the ability to purchase unexpected, necessary expenses.
But why would the size of your credit card payment limit your ability to accommodate unexpected expenses?
Let's
say you have $1,100 cash, and your minimum credit card payment is
$500. Let's say you expect expenses of $500, and so you pay down your
credit card by $500, using almost all of your available cash.
Now, let's say that necessary expenses turn out to be $1,000, not $500. You don't have the $500 in cash to pay for them.
What's preventing you from using the credit card itself to purchase the extra $500 in items?
Or,
if the seller doesn't accept credit cards, what's to prevent you from
writing a check drawn on your credit card account? Or, if the seller
doesn't take checks, what's to prevent you from doing a cash advance on
your credit card in order to pay the seller with cash?
Sure, it's possible that the seller won't take credit cards, or the seller won't take checks, or your credit card company won't allow cash advances. But it's not very likely that all three options aren't available!
You
might think it would be an inconvenience to put yourself in a situation
where you might have to do a cash advance or write a check. Right?
Well, whether you consider the minimal inconvenience worth it depends on how much you value money!
Let me explain the benefits of making the larger payments!
By
making a credit card payment $500 greater than was necessary, you've
saved the interest on $500. At an annual interest rate of 18%, you'd
save an easy $7.50 if it turned out that the unexpected $500 expenses
occurred one month after you made the excess credit card payment.
And
there are other benefits: Because you made a larger credit card
payment, your credit card company may view you as being a financially
stronger customer, and may be more likely to raise your credit limit,
given that they are more likely to feel you can handle the extra credit
they provide.
In
addition, when the credit card company sees you make a much larger than
necessary payment, it may become worried that you plan to pay off your
credit card completely, thereby reducing their interest revenue on your
account to zero! In an attempt to ensure they keep your business, they
may raise your credit limit, hoping you will have enough available
credit to use your card for a purchase that you were previously unable to make (due to not having enough available credit).
In
addition, when you use your credit card to purchase the unexpected $500
of expenses, many cards will offer you 1% cashback on the purchase!
That's an extra $5 that you wouldn't have gotten had you paid with cash
put aside!
Also,
by making the extra purchases with your card, you provide the credit
card company extra revenue from the transaction fees they take from
merchants (for example, they might charge merchants 1% of the price of
the item being purchased, in exchange for providing the merchant with
the convenience of offering credit card purchases to customers). As a
result, you'd be a more valuable customer to the credit card company!
The credit card purchases could also improve
your credit usage profile in another manner. By using your card for
purchases, it could suggest that you feel you are in good enough
financial shape to be able to pay off those purchases. True, this isn't
always the case, but the scenario I outline is an improvement over the following scenario:
Let's say your finances are so weak, or your credit limit is so low, that you don't normally make any credit card purchases at all.
Only payments. Credit card companies might consider that to be a
potential warning sign of financial distress. But by making a larger
payment on your card, it frees up your available credit so that you can
begin making purchases again. In turn, that makes you appear healthier
financially, and might increase the odds of you receiving a raise of
your credit limit, or being offered lower interest rates.
If
it turns out that credit cards can't be used to purchase the unexpected
$500 expenses, you can often do a cash advance to get the money. That
advance might cost you, say, $2.50. You'd still be ahead, because you
pay a $2.50 fee in order to save the $7.50 in interest during the
previous month!
2) Let's continue looking at the rest of her "tip":
"If not, you’ll end up relying on your credit card to cover basic living expenses..."
As
I already explained, yes, you could end up using your credit card to
cover the unexpected expenses. But I've already shown that such use
would likely benefit, not harm, you!
3) "...and you’ll be stuck in the cycle of making payments while racking up more debt at the same time."
Huh?
How would you end up racking up more debt? You'd be using the credit
card to purchase items that were necessary, items that you would've
purchased anyway had you instead used the cash that you put aside!
Using the credit card doesn't result in an increase in debt at all!
Conclusion
Clarky Davis is dead wrong on this one.
And for my readers, I hope you consider me to have made an interesting, less than obvious, discovery! :)
And for my readers, I hope you consider me to have made an interesting, less than obvious, discovery! :)
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