I once overheard my wife’s co-worker complain that her credit card was shut down because she had failed to pay any of the bills. When she found out about this, she shouted, “They can’t take away my money!”
What’s wrong with this picture? To the financially literate, it’s immediately obvious that the line of credit is the bank’s money, not hers, but she didn’t understand that at all, which is why she was in default on pretty much everything she had.
The ability to borrow is not wealth. The availability of credit is not wealth. This seems like such an obvious thing to say, but it’s so frequently misunderstood. When you pull out plastic at the shopping mall or grocery store, you are paying with someone else’s money. You must in turn pay back that money, or suffer the financial consequences.
In a way, all borrowing is gambling.
When you use a credit card, you are gambling on having the money at the end of the month to repay to the credit card company. As long as you have exactly the amount of cash (plus fees, if applicable) in your bank account as you do on your credit card, that’s a safe bet. If you have less cash than you borrow, it’s no longer a safe bet.
When you take out a loan for college, you are funding your education on a bet: you are borrowing against future earnings. You are gambling that that someday you’ll earn more than you owe and can make good on the bet. Sometimes that’s a good bet. More frequently than you might guess, it’s not a good bet at all. There are plenty of graduates out there with an art degree, $200,000 of debt, and a job at Starbucks.
When you sign the dotted line on a mortgage for a house for the purposes of investment, you are gambling that the price of the house when you sell it will be higher than the price of the house when you buy it. Obviously, if you live in the house during that period, you gain the use of it and the value of sleeping in that house versus, say, a cardboard box, but if you buy the house for the purpose of investing in real estate, you are gambling.
Every debt is gambling on your ability to repay. How much risk you take – how unsafe your bets are – is highly dependent on your ability to repay. If you borrow more than you are able to repay, you lose 100% of the time. If you live on the edge of being able to sometimes make your monthly payments and sometimes not, that’s a pretty awful state to live in, full of stress and worry.
Place your bets carefully. Know what you’re capable of earning. To paraphrase the famous quote from Top Gun, don’t let your ego (or attraction to status, shiny objects, etc.) write checks that your body can’t cash.
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It’s always amazing to me that people don’t understand that if you don’t pay your credit card bill, you’ve essentially stolen the item you “paid” for with credit.
Debit cards are great for learning more about money management because they keep you honest, by debiting the amount from your bank account and cutting you off if you over-spend. Ideally, that should never be an issue anyway… We’ve set up auto-debits into our savings account as well to make sure we have that rainy day fund when we need a new roof, a car repair or other unanticipated expense, or have money for “play” when warranted.
Living within your means and earnings should be the first lesson, then compiling a nest egg for unpredictable circumstances, and then investing/saving for the future. Ideally, you can do all three of these things at once, but spending less than you make is step one.