Plastic stretch marks
Credit card debt is easy to get into, difficult to get out of. David Kohl's tips on successfully managing the plastic.
Many of you know the feeling. It's after the holidays and the long winter days have set in. You step on the scales and your face becomes flush. You have put on those extra five to 10 pounds. Oh, it's so easy to put on but so difficult to take off. The same thing can happen in credit and debt, particularly with today's easy access and convenience.
Credit card debt with agricultural producers and the public has become a telltale sign of the 1990s. As we entered the 1990s, 32% of households had a balance on their credit card of slightly more than $2,000. By decade's end this percentage had nearly doubled and the balances quadrupled to nearly $8,000.
What's the Problem?
Many people ask what the problem is with a $4,000 dollar credit card debt when they have a $200,000 farm mortgage or an equipment or livestock loan of $100,000 with the bank.
Credit cards are an excellent debt instrument tool if used properly. I recommend at least one credit card for university students because it will become a necessity if they travel or purchase items over the telephone or Internet. It can be used as a method to establish and enhance your credit reputation.
Many producers use credit cards as a convenient and low-interest form of financing, particularly in the introductory stages. Some have discovered the benefits of frequent flyer points or incentives for that vacation or new pickup. However, personal observation has found that for every one person that can do this effectively, there are 10 that have difficulty.
The pitfalls
In recent years I have observed more credit card debt on the balance sheets. Yes, your lenders will ask you to disclose this on either a personal or business balance sheet. A grain producer I met had 97 different cards with $505,000 of credit card debt. While that is an unusual case, it's not uncommon to observe $15,000 to $20,000 balances.
The problem comes when balances increase to an unacceptable level. For example, as a general rule, if the balance exceeds one fourth of your five-year average of net farm and non-farm income, it is a yellow light or caution sign. If the balance exceeds one half of your five-year average you are in a red light or critical situation in short-term debt management. Filing for bankruptcy or refinancing against equity could either ruin or seriously hurt your credit reputation for up to a decade or more.
Lenders will not only examine your balances but your overall limits on each card. For example, if you have four cards with $20,000 limits, this is an $80,000 unsecured line of credit that can be used at your discretion. If you have had a history of repayment problems with institutional lines of credit or credit cards, this will also be taken into account.
And don't forget about the balances carried on your spouse's credit cards. There have been instances in recent years where one spouse discovers abuses of a credit card by the other when the credit history report was analyzed. Usually this leads to some heated discussions and exchanges.
Caution should be observed concerning credit card abuses with youth. For example, the average American university student has an $1,800 balance. It's not uncommon to see $5,000 to $20,000 balances. Further analysis found that they were used not only to purchase books, but also to take vacations or to purchase food and entertainment.
The Jordan Rule
One of my favorite lectures for youth is the Michael Jordan Rule of credit card debt. That is, if you use a credit card to purchase a $2,000 computer and make minimum payments at 18% interest, it will take 23 years (Michael Jordan's number was 23) to pay the balance. Take the same minimum payment amount, invest it in a modest return mutual fund and 23 years later you will have nearly $40,000. Ah! The power of credit, investment management and youth – where time is on your side.
Final Thoughts
Yes, credit cards are a valuable credit tool, a convenience and a credit reputation enhancer. But like that big sweater that hides 10 extra pounds, credit cards can cover up business or personal cash flow problems, poor investment decisions, or binge purchases based on emotion. Whether stepping on the scales or receiving your credit card statement, lack of discipline can challenge the best of us.
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