Uses and Abuses, Tips and Tricks About Debt

Last April, I watched as my eldest son drove out of my driveway in his loaded-down Subaru with a brand-new Thule box on it, headed for Utah with all his possessions loaded in his modern-day Conestoga wagon. As many of you know, a month later he fell off a cliff and received a terrible spinal cord injury. (Happy update: it was a terrible adventure, but thanks to a whole host of blessings, he is nearly fully recovered and was back to work three months later). What none of you know is that he had opened up an L.L. Bean charge card to get 15% off his purchase when he was buying the Thule box. He planned to pay it back over time once he started his new job. But when he was injured, I jumped in and paid off his L.L. Bean credit card in full. Why, you may ask, am I telling you this?

The effect on his credit rating was immediate and torrential: he has gotten dozens and dozens of credit card offers since then.

Credit ratings are a combination of a bunch of separate things, but they’re all designed to answer a simple question: can a creditor reasonably expect that you will pay your bill a month later? Do you have a history of receiving your mail, reading and responding to it with a check? If not, you’re not a good credit risk. Maybe it’s because you don’t get your mail, maybe it’s because you aren’t organized enough to get around to paying the bill, maybe it’s because you don’t have money. They don’t really know how much money you have, so they try for proxies: how much credit do you have access to that is not being used? Do you pay bills in full or over time?  Do you skip months as you juggle which is highest priority to pay?

This twenty-three year old also has some direct student loans that we have set up on auto-payment. Payment history is helpful, too. That’s partly why it’s a good idea to keep old credit cards open and unused: it shows how long you’ve been a customer as well as unused credit.

There are three credit rating agencies and you are allowed to get a free copy of your credit report from each of them once a year. That means that you could check one or the other every four months if you wanted to monitor what is being said about you. It’s hard to read them, but you’ll quickly figure out if there’s something on there that doesn’t fit. For example, you may have a L.L. Bean card you forgot about from 6 years ago on it, but the balance will be zero. That’s not a problem. The problem is if there’s a car loan at a bank in Indiana. Wait, what? If it truly isn’t from your life, you’ll notice. It’s a good thing to check once in a while. Go to Annual Credit Report  to request a free credit report.

Credit is tricky.  Some is good, some is bad, and a bunch is in a gray area. Debt says “the future is so bright, it can afford to pay for the past, plus interest!” But debt also gives you leverage, which says, “I’m going to share the risk with the bank and free up my money to use in better ways.” Generally “self-liquidating debt” is good: that’s where borrowing the money will help you to make more money; borrow to buy business equipment that poises you for growth, for example. Student loans typically fall into that category – at least at first.

Direct Student loans max out at $31,000 for undergraduates. I’m a big fan of those. Good rates, reasonable forgiveness terms, reasonable repayment options, and there’s close to a 100% possibility that borrowing $31,000 to get a bachelor’s degree will have a good return on that investment. In any case, it won’t ruin your life. I’ve seen financial aid “award letters” that try to make it sound like you should go borrow $30,000 for the year over and above the Direct Loans. No! That’s just a conflict-avoidant way of saying you can’t afford to go there. The expected family contribution is designed to come from savings and earnings, not new debt. Keep looking until you find a school that isn’t gapping you on your financial aid need.

I’m not a fan of banks grabbing 3% of gross retail sales in the country through credit card charges to retailers, but there are many upsides to using a cashback card as a consumer for those times when you aren’t paying locally. (Local firms like mine prefer cash or checks exactly because we don’t like the banks taking 3% off the top, though!) One of the best reasons to use a card is so that they can track the categories of your spending. When I ask you how much you spent on gas last year, you’ll be glad you have a report totaling that up! The trick with cashback cards is that you need to pay them in full each month. If you need to carry a balance it’s better to have a second card for that: one structured with lower interest rates and balance transfer offers as opposed to cash back offers.

If you’re troubled by debt, by money washing through your hands, a good trick is to add up all the things you’re going to spend money on over the course of a year that ISN’T a regular monthly bill. Vacations, clothes, Christmas gifts, car repairs, vet bills, heating oil or insurance bills that land at odd times. Just looking at that list will help to improve your gut-level budgeting. Those costs are real and need to be factored into what you can spend, even if the bill isn’t already sitting on your desk.

Another trick with regard to debt: put a line in your budget for the cost of buying a car. Use it to pay your car loan, then keep it in your budget and redirect the loan payment into a car savings account. Your car just got $300 closer to dying this month: that was this month’s consumption. Save in between car loans and someday you’ll find yourself in retirement able to buy cars with cash.

Published Nov. 22, 2016