I came across a Frontline documentary on the “secret history” of the credit card industry, and I found it fascinating how it described its development from a small, niche product to system that now pumps out billions of mailers every year enticing people to sign up for the option to pay over time. I’m fortunate, I guess, that my parents were such tightwads (at least when it came to giving me direct access to money). I remember when I was very little I wanted to buy a book one time from a garage sale. It was 10 cents. My siblings and I scrounged all day to find pennies behind seat cushions and on sidewalks to pay for that book.
My parents never entertained the idea of loaning us money back then. Even when I got my first allowance, I didn’t actually get to handle the cash. My dad just kept a business card in his pocket and would add a dollar to the balance every week. Eventually, my allowance grew. I also became responsible for buying just about anything I needed except for food and shelter. I was so proud of the first time I saved $1,000. Paying for things myself, and only paying what I could afford, became second nature.
Any person interested in applying for travel rewards credit cards should watch this Frontline documentary. Even if you think you are responsible with your finances, you may not be. Megan and I are fortunate that we were raised with good habits and yet… it is still difficult for us. Sure it’s a little outdated what with recent improvements in consumer protection laws, but the basic premise — that banks make money off your impatience and poor planning — still holds. I like the video because it includes both sides of the story, at least as far as you would expect. Most banks and their consultants were understandably hesitant to speak freely.
The one rule Megan and I always stick to is that we don’t buy more on credit or charge cards than we can pay off, in full, every single month. All credit cards charge interest, and rewards cards charge even higher interest. More than annual fees, banks make their money from interest rates. Ben Stein is interviewed at one point and says banks view him as a “deadbeat” because he always pays off his bills.
Bill Stein is the banks’ worst customer. You should want to be their worst customer, too. Because even though they aren’t making them that much money from interest on you right now, they can still hold out hope that you’ll screw up some day. Meanwhile, big spenders continue to be treated well since transaction fees on every purchase certainly don’t hurt. Spending money and paying the bill is better than not spending any money at all.
In order to manage good spending habits with plastic, you have to be willing to see credit cards not as a loan but as an alternative form of payment. My credit cards are convenient. I earn valuable rewards. But I don’t buy things I can’t afford to pay back as soon as possible. Most of the people I know who are active users of credit cards to earn free miles and points are actually very well off. Many of them are executives, lawyers, doctors, and consultants. Others are just extremely good at keeping track of this hobby so they don’t make any mistakes.
No one said you had to be wealthy to manage your money well. I started this hobby when I was in graduate school, splitting my $2,000 monthly income so I could put half toward living expenses, a quarter toward savings, and a quarter toward travel. Lately we’ve cut back on travel to pay for our wedding, and though I make a little more than $2,000 a month now, my living expenses still haven’t gone up. Down, actually, since we’re saving for the wedding.
Debt certainly has its place. I’ve borrowed money from family when I had a short-term liquidity issue, or when I wanted to diversify my credit profile (e.g., getting a small loan on a car even though I had the cash). But every loan needs to be paid off eventually. You can be sure that I integrate those loan payments into my monthly budget before signing on the dotted line. You should do the same before you charge more than you can repay onto your credit card. The problem is there’s no lengthy contract to remind you of what you’re agreeing to every time you buy a $4 latte.
Here are some key points you should take away from the video:
Credit card loans are unsecured. There is no physical asset a bank can seize in case you fail to pay, unlike a mortgage or a car loan. This is why credit card interest rates are higher.
A line of credit is meant to be a short-term loan. If you pay quickly, changes in interest rates generally won’t affect you. It used to be that the bank could later raise your rate and it would apply even to older balances. New credit card reform laws have changed this so that the rate can only be increased due to default (and only on the affected account). The old rate will be restored once the consumer re-establishes a good payment history.
Interest rates can change with very short notice. It’s an ongoing line of credit, and so the terms can be altered. Again, new laws have changed this to require 45 days’ notice, but that isn’t a lot of time if you’ve been accumulating a balance over several months or years.
If you make a late payment, you are a riskier customer than someone who never made a late payment. Although a bank can’t raise rates on Account A just because you defaulted on Account B, the overall business climate may still lead a bank to raise rates on everyone (just like a rent increase).
On the other hand, I observed some shocking qualities in the people Frontline interviewed:
None of them knew their credit scores. Some didn’t even really understand what a credit score was. I can tell you my scores, and they’re all over 780 (very good).
Some of them had plenty of cash in the bank to pay off their cards, yet they still carried a balance. Their argument was that the cash was a safety net. But is it worth having that safety net if it means you’re paying several hundred dollars in interest?
It’s definitely a challenge to balance the protective powers of the government against meting out punishment for people’s bad decisions. There’s always blame to go around. We want to take care of the individuals, because they’re more relatable than some anonymous corporate bank, but that doesn’t always mean they deserve our sympathy. Some people just don’t know how to manage their money. Some people know and just don’t care. Hopefully before you get head-over-heels in credit cards you’ll take the time to learn more about using them responsibly.