What Do Rising Interest Rates Mean for You?
Comedian Bill Engvall’s signature punchline is, “Here’s your sign.” In good fun, whenever anyone says something obviously foolish, he jokes they should be wearing an “I’m Stupid” sign. And if Engvall was writing a routine for today’s economy about credit card debt, he might end it with his famous line.
Short term interest rates are the most affected when the government nudges up the federal funds rate, which will likely raise rates a quarter point. This will be the third move since December 2015 when rates were effectively zero. But that’s not the end, there’s one more move expected before the end of this year.
What does that mean exactly? If you have a credit card with a 15% interest rate, it is now 17%.
With nearly a trillion dollars in credit card debt among American households, and many of them only making minimum monthly payments, the interest charges are going to balloon their balances.
If you have a card with a $10,000 balance, paying the minimum will cost you $12,000 in interest and 27 years to pay off at the 15% interest rate. At 17% percent you’d pay $13,6000 in interest and take an extra year to get out of debt.
If this scenario hits close to home, “Here’s your sign.”
The concept of credit cards has been around since the 1920’s when oil companies and hotel chains began issuing them for purchases made at their outlets. The first universal credit card was introduced in 1950 by Diner’s Club Inc. Eight years later, American Express Co. issued its own. So began the movement of borrowing for consumption.
When I was young, people lived from paycheck to paycheck. Credit card use increased dramatically with customers spending more than their income. Today, it seems like they live from credit card payment to credit card payment.
The financial crisis of 2008 led to a rise in defaults, and in April 2009 the U.S. House of Representatives approved the Credit Card Holders’ Bill of Rights, which would provide additional consumer protections and restrict or eliminate credit card industry practices deemed unfair or abusive.
To give consumers a quick answer to their problem, many financial experts have said repeatedly, “Get out your scissors and cut up your credit cards.” While this may sound like good advice, to me it seems like a painful, short-sighted answer to a more complex problem.
That problem is a lack of financial education. Why don’t we teach kids about money in school? Rich or poor, smart or not-so-smart, we all use money. Yet, while there are a few schools beginning to offer some financial education, it seems that most educators believe money isn’t a subject worthy of the hallowed halls of our learning institution.
Debt Can Be Good OR Bad
In another issue, I told you about the Rich Dad Scam, “Get Out of Debt.”
If borrowed money is simply spent on consumption—a vacation, jewelry, or shoes that you charge to your credit cards—that is the bad kind of debt. The car loan that you write a check for each month is bad—debt that you pay for out of your own pocket.
The advice generally given if you are struggling in massive amounts of debt is:
- Pay off the credit card with the highest interest rate first.
- Pay a little more every month on every debt you have.
- Cut your monthly expenses.
Good debt on the other hand is debt that someone else pays for you.
A good business person may borrow money to grow a business. That debt is good debt if it is paid back out of the positive cash flow of the business. When you purchase a rental property, you will most likely have a mortgage or loan on the property. If you manage the property well, then the rent from the tenant pays the monthly mortgage payment. That is good debt.
Whenever anyone asks me how to solve the credit card problem, I tell them to fight fire with fire—debt with debt. The way I solve my increasing needs for cash is to go deeper into debt. I never get myself into consumer debt, though. I use leveraged money to purchase cash-flowing assets.
For example, I use debt—which is essentially tax-free money—to invest in real estate, which in turn increases my cash flow. Not only do I not pay taxes on my debt, I could also pay no taxes (or very little in taxes) on the income from the debt. Hence, I earn more but pay less in taxes.
Obviously, in order to do this, you need to know how to use debt wisely and responsibly and must be able to find great investments that increase cash flow.
The Root of the Problem
Most financial experts will scoff at my “fight debt with debt” approach.
They’ll say my advice is based on flawed logic, and it may well be for most people. But I ask you to step back and take a look at the world of finance. Wall Street is able to take your debt and turn it into their asset. That’s what financially smart people do, and it’s one example of why rich people get richer.
Unfortunately, most balloon their liability-based debt into a chokehold on their whole life. This is especially true of poor people and people with bad credit, who have access to only the worst forms of debt and pay the highest interest rates on it.
Their problem isn’t credit cards, but a lack of financial know-how. And at the root of that lack of knowledge is our school system and its archaic curriculum, which is out of touch with the way people really live.
Clearly, advising people to cut up their credit cards won’t solve the problem of excessive credit card debt. A pair of scissors won’t make anyone financially smarter, but any understanding of good vs bad, assets vs liabilities, just might make things clearer.
Cutting up credit cards won’t address these economic changes or solve America’s debt problem.
In the real world, credit cards are essential. It would be extremely difficult to rent a car or make hotel and airline reservations without a credit card. It would also be tough to pick up the tab at a business lunch or shop online without a credit card.
Those are all things that make quality of life a lot higher. And what’s the point of getting out of your hindering debt if you can’t enjoy a more comfortable life?
Personally, I love my credit cards because of the freedom and convenience they allow me, and my life would come to a grinding halt without them.
I’m sure a lot of you feel the same way.
You can fix your problems with debt by reducing your liability purchases, and making up for them with the purchase of assets. Then the cash flow from there should pay for all the cars, shoes, and lunches you really do want to buy.
Play it smart,
Editor, Rich Dad Poor Dad Daily