Congress Can't Fix Your Credit Card Problems
While Congress is debating new rules for credit card companies, there's a harsh reality about credit cards that you can't escape.
When you carry a balance on your card, you've taken out a loan from the credit card company. This is the worst type of loan that a lender can make, which means the terms will always be lousy, no matter what Congress does.
You see, credit card loans are mass marketed, non-secured consumer loans. This means there's nothing standing behind the loan besides the consumer's naked promise to pay. And with the easy use of bankruptcy, it makes collecting on these loans even riskier.
Because the loans are so risky, the terms of the loans must compensate for the possibility that they won't be paid back. Thus card companies demand high interest rates and penalties for non-payment.
You might be wondering why Congress can't just make the card companies charge less interest. Well, credit card companies must raise money from investors. This is where the companies get their money to lend out to credit card holders.
- Investors know how risky the credit card loans are. So they demand that the card company run a profitable business by charging high rates of interest.
- If the credit card companies don't structure the terms to compensate for the risk, they can't raise money from investors.
- By the way, if you own a diversified stock or bond fund, you're probably an investor in credit card companies.
But even if we fix these "abuses", you can't escape the basic truth that credit card debt is a terrible loan. The nature of the transaction is high risk, which means one way or another borrowers will pay high fees and be under harsh terms.
Also consider that if you carry a credit card balance, it's severely hampering your ability to save for retirement. For instance, if you carry a $10,000 balance at 15 percent interest, it costs you $1,500 a year just to maintain the loan.
This is $1,500 that is being wasted. If you get rid of the balance, you could take and save that $1,500 in your 401(k) plan. Plus, you'd get an income tax deduction for the contribution, which probably saves you another $300 in taxes, assuming you're in the 20 percent bracket.
If you did this for 25 years, earning 7.5 percent on your money, you could accumulate almost $110,000 in your retirement plan. Or you could give that money to the credit card company and let them pay their executives with it. Your choice.
Bottom line: Don't carry a balance on your credit card. No matter what Congress does, it is and will remain a terrible way to borrow money.
Credit card photo from Flickr, courtesy of Andres Rueda, CC 2.0
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