Thursday, November 05, 2009

Live within your means, and credit cards are blessings

Tangentially related to the recent post looking at the relatationship between intelligence, conscientiousness, and credit scores at the state level are discussions over tactics to build (or more accurately, inflate) one's individual credit rating. Not long ago, Razib emphasized a few ways of going about this (the web is, incidentally, brimming with this kind of advice), but that's not where the impetus for this post comes from. Instead, it springs from the following:

I talked to another GNXPer recently who didn't have a credit card. Until last year I didn't have one either. My theory was that I lived within my means, have few expenses, was healthy, etc. etc. I know plenty of people like me, young, intelligent and not too interested in signalling with positional goods and such, who didn't get caught up in the real estate craze, and so made a calculation that there was no need for credit (at least for the time being).

Disregard the issue of needing to build good credit for a moment. I've had a credit card since turning 18, despite the personal irrelevance of my credit score, since I've never borrowed money (and never will borrow money) for anything in my life. Yet credit is the virtually exclusive way I go about paying for stuff. As long as you're not so interested in signalling with positional goods that you find yourself unable to pay off your balance each month, there are no reasons not to have a credit card and several economic costs incurred by way of not having one:

- You forgo the TVM advantage of being able to enjoy your half of an economic transaction now without having to pay for it until later. If you have $2,000 a month in total living expenses and it all goes on the card, you're holding $1,000 for 30 days longer every month, give or take. At 6%--which, a couple of years ago was attainable with the safety of a money market--that's $5, twelve times a year. Additionally, if uncertain circumstances create a need to pay for something immediately but for which you lack the necessary funds in your account until tomorrow, it doesn't present a problem.

- So $60 is chump change, not even worth thinking about over the course of a year. Au contrare! It buys me this and this. And anyway, it's effortless. Receive statements online, tie them to a liquid account with online bill pay, and a month's worth of stuff is taken care of with a couple clicks of the mouse. That's less of an energy expenditure than is fumbling around with paper bills or punching in your PIN repeatedly. More and more retailers are moving away from even requiring a signature on small credit purchases.

- Speaking of fumbling around with bills, plastic means you don't have to. No more getting nickel and dimed to death by losing the nickels and dimes given to you in change. Debit cards provide this benefit as well, of course, but if your debit card is lost or stolen, you risk your account being cleaned out without much in the way of recourse. With credit, if you didn't make the purchase, you're not on the hook to pay for it. In reality, it's not quite that simple, but the debt obligation lies with the card provider, not the account holder, and the major players--Visa, Mastercard, Discover, and especially American Express--will, for their own good, go to bat for you.

- There are a slew of different bonus and rewards programs for credit card users to take advantage of. If frequent flyer miles don't elevate you, go for cash back to the tune of 1-2%. That's free money*.

- It's the quickest, easiest way to do business online. While services like Paypal are also convenient, if the item shipped is defective (or never shows up), securing a refund is more of a hassle (not to mention more of an open question) than it will be if you had paid with credit.

* Sort of like government-provided universal healthcare is free. Retailers and service providers essentially remit around 2% of each transaction price paid via credit to the card providers for the 'privilege' of being able to accept their plastics as a form of payment. In the case of products with razor thin margins, like gasoline, in practice this often means Visa is making more revenue on the sale than the retailer is making in profit. This is a cost imposed on retailers and service providers that is factored into the prices they charge for the things they provide. Thus those who pay with cash (no fees) and debit (lower fees) are subsidizing those who use credit. What, do you feel a fiduciary obligation to Macy's? Or Macy's high-risk cash customers? Use your damned credit card! It's one of the few ways you, as a prudent, self-reliant person, are able to be rewarded for your self sufficiency, rather than being punished for it.


Jon Claerbout said...

Hold on! You don't get to hold their money for 30 days. They give you a 3 week period and you won't even receive the statement from them until several of those days are gone. I hope you are not on vacation because if you pay up a few days late, you get smacked with a fee that far out weighs your imagined time value of 30 days interest.

Phoenixism said...

Yes, perfect bullet list of proper and conscientious (!) ways to manage your credit card use. This kind of thinking makes banks cringe. Where would they be without short-sighted and consumerist impulsiveness.

My general rule of thumb is that I don't purchase anything that I can't pay within the statement period. And if it's a large enough purchase, I prefer to dip into my savings to pay for it anyways. Once you enter the maze of revolving payments, you've lost the battle, in case you care.

I think a good, half-stated analogy would be "using credit cards is like paying for a prostitute...."

agnostic said...

Something that most people here (including me) might not remember, not having been alive back then, is that consumer credit terms used to be a lot worse. Here's a good summary from EconTalk:

Podcast here

Instead of a single line of credit from a bank with lowish interest rates, you used to have to take out a line of credit with every firm you bought a big-ticket item from, and at much higher interest rates.

We hear lots of complaints about banks targeting huge groups of people for their credit card mailings, but that's good -- allows them to realize economies of scale and diversify their risk over geography.

The neighborhood car dealer, furniture store, etc., couldn't do that, hence tremendously higher interest rates.

Razib said...

good points. only issue for me: pain of paying. i make small purchases on debit, and my rare large purchases i will make on credit. mostly because i can keep track of the large purchases in my head, but the small purchases not so much. so i minimize my small purchase consumption by knowing that i'm not deferring payment.

the issue with debit card liabilities being more on you is the main reason that i am thinking of switching to credit. but, i am somewhat paranoid about checking that i have my wallet or my bank account.

Audacious Epigone said...


It's possible to hold for longer than that if timed right. If the transaction cutoff is the 10th and payment is due on the 25th, a charge you make on the 11th won't be due until the 25th of the following month--six weeks later.


Right, it's a benefit for people like you and me. Issuers would prefer we be buy beyond our means, but they're still making money off of us by way of the retailer or service provider.


I listened to my first econtalk podcast a couple of weeks ago on your suggestion and it has quickly become one of my favorite places to get audio discussions.

FuturePundit said...

Jon Claerbout, You can get email and SMS notifications of new bills and also of nearing pay dates from some credit card providers. So forgetting to pay isn't such a big problem.

Plus, you can check your current charges online before going on a vacation and pay those charges then (or just schedule those charges to be paid while you are away). You can even pay in advance based on how much you expect to spend.

silly girl said...

The point of not borrowing money is based on borrowing because you can't afford to pay cash for something. This ignores the importance of liquidity. For example, before I married, my husband had bought a small house. Although he had enough to pay for it outright, he was making more off of the money by keeping it in liquid assets than he paid in interest on the mortgage. Had he paid for the house outright, he would have tied up a high percentage of his assets in a house which is not nearly as liquid and lost money on the arrangement as well. Same when we bought a new house. We could have bought the house outright by taking money out of profitable investments to avoid a mortgage, but we got an insanely low rate on an ARM which allowed us to keep money in far higher earning liquid investments. It would be stupid to miss out on 5-7% annually on $200,000 just so you can say you never borrow money.

Phoenixism said...

@ silly girl, that is certainly accurate within the context of a large, extended loan for a home purchase. However, I think this sort of financial justification practiced on a daily basis (buying barely expensive luxuries like 52" TV's or super gangsta rims for your Civic) will inevitably lead to harder times.

Audacious Epigone said...

Silly girl,

The mortgage interest tax deduction artificially skews people towards taking out loans even if it is not a financial necessity. If it is easy to consistently realize returns greater than 7%, however, it raises the question of why banks would participate in such lending in the first place. Are they not foregoing a better ROI?

I lucked out. Against the advice of several people close to me, I bought my house outright in June of '06. Pretty close to the real estate peak, nationally. But prior to that, I'd had about 70% of my savings in equities (I'd been steadily drawing down from 90% to money markets for over a year out of nervousness). House valuations in my neck of the woods have been flat for the last couple of years, so a good chunk of my financial resources have treaded water. Had I kept the money for the house in the market, however...