Myth: Credit Improves Your Quality of Life

The Word on the Street

There is a general opinion (fostered by aggressive advertising campaigns) that using credit will let the borrower have goods and services they could not otherwise afford, and thus improve their quality of life.

The Truth

Credit, whether a mortgage, credit card, home equity loan, installment loan (ie making payments on a tv, washing machine, sofa, etc.) reduces your standard of living by taking money out of your pocket.

Doubt me? Let’s take a look at some very simple principles of credit and interest and see if I am right.

Credit Costs

Let’s stop for a moment and really think carefully about what credit is. Buying on credit means that someone else pays for your purchase, and then you pay them back for it. This is, of course, not a free service. The fee charged by credit companies is given a fancy name; they call it interest.

When you slap down a credit card, or get a new bed on installment payments, you are agreeing to pay more for the item than the sales price. Think about it: if you buy a $500 TV and pay cash, you will pay $500 for the TV, and no more. If you pay on credit, then you get the TV for $50/month for 12 months. $50/month x 12 months = $600. You just paid $600 for a TV that only cost $500 to begin with. You lost $100. So, while you may have the TV a few months before your friend (who paid cash), he will have not only a TV, but also a DVD player. So whose quality of life is higher? You, with your TV and $100 lost on interest, or your friend, with a TV and a $100 DVD player?

This is the great trick that marketers play on consumers. When was the last time you saw a car commercial where they told you the purchase price of the car? They are very rare. Why? Because the dealership doesn’t want you to pay for the car upfront; they want you to finance the car (or better yet, lease it!). They make much more money that way. Can you blame them? What if you were selling your car? Would you prefer $1000 up front, or payments of $200/month for 7 months? In some situations, you may need the cash immediatley, but if you can wait for the money and get an extra $400 for your patience, wouldn’t you do it? So the next time you are tempted to buy something on credit, just think: how much interest will I pay, and if I don’t pay interest, what could I do with that money instead?

Posted on 5 Sep 2008