Learn to Leverage a Credit Card
How you can be a chess player with your credit card
At the Porsche Club of America event in Dana Point, CA, I interviewed a Porsche owner who shared her journey and experience with money. I initially asked her the question of "what is something about money that you wish you would have known when you first started working?" Her answers ranged from saving for a wedding dress, savings bonds, and retirement. However, one answer deserved greater attention and that was the one she gave regarding the credit system.
Watch the video:
The credit system for any country works generally the same. With my personal past negative experiences along with my understanding of financial systems and markets, the credit system is a game and if you know how the game is played, then you can be smarter with money.
First Principle Analysis.
A credit card is a loan from a financial institution that chargers the borrower interest in order to profit from the loan.
"But, the credit card company is offering 0% interest for a year, so they aren't making money off me!"
To think that you are able to outsmart a financial institution only makes you a target. Credit card companies think and act 10 steps ahead. You see 0% interest for one year. They see a customer in debt for the next four years. But more on this later.
A credit system is nothing more than financial institutions and the government collaborating to certify that borrowing money is safe and legal. Both entities encourage borrowers to become debt holders because financial institutions profit off this debt and governments remain relevant by acting as a trusted protector of the borrower. This gives the illusion that you not only have a roof over your head, but you have a warm blanket to comfort you.
Financial technology companies like Affirm, PayPal, Block, and others implement a similar credit card model called “buy now, pay later.” At the point of purchase, the consumer can opt to make payments instead of paying-in-full. Affirm secured a partnership with Amazon which allows consumers to make payments on certain high-ticket items like furniture and tech devices, rather than paying the price upfront. Depending on the terms and conditions, Affirm may offer payments at 0% interest for six months, then if the item is still not paid in full, then an interest rate kicks in until the item is paid off in full.
The Fine Print.
"A penalty APR (annual percentage rate) applies up to 29.99% if: 1) you fail to make a Minimum Payment by the date and time that it is due; or 2) make a payment to us that is returned unpaid.
We will end your introductory APR if any required Minimum Payment is 60 days late, and apply the Penalty APR."
Any 0% interest rate credit card is a promotion whereby the borrower receives 0% interest on the amount they borrow for a set number of months AND as long as the minimum payment is made on time. The minimum payment will always be stated on the credit card statement.
If the borrower misses the payment date or if the payment is returned, instead of paying the normal interest rate (after the promotion expires) of 18%, the borrower pays 29.99%. On a $3,000 loan, the difference between 18% and 29.99% is $360 (total interest cost is $540-$900).
Reading the fine print of any credit card is crucial to making good financial decisions.
Additionally, once you have one credit card, these companies begin to target you with more credit cards, more special promotions, and while you may say no five times, even ten times, you also know that having a credit card gives you more buying power in the present day. As hard as you play to get, credit card companies play harder with their persistence. And they're winning. In the US alone, total credit card debt is just shy of $1 trillion and the average credit card debt in 2021 was $5,221 per debtor.
Credit card companies are 10 steps ahead of the consumer and play the game of chess. They know it's only a matter of time until you pay interest, until you pay late payments, and until you secure a third card to pay off the first two cards! (Yes, this happens all too often.)
Be a Chess Player Too.
"I didn't create the rainy day, I just have the best umbrella."
Being a chess player in the credit system is not a zero-sum game where you are playing against the system. Rather, the more relevant question is how can you be a chess player, think and act 10 steps ahead, and use the system to your advantage?
The first question to answer is why do you, or anyone, need a credit card? The only two appropriate answers are needing access to capital and to build one's credit. However, another more common, short-sighted answer is to defer the full cost of a product or service in order to save money in the present.
There is a difference between deferring the cost and needing access to capital. The former suggests that the borrower is using a credit card to purchase products or services that they may lack sufficient funds to purchase now. The latter suggests that the borrower has intentions of purchasing products or services that yield something greater than in the future.
Using a credit card to purchase products or services because you may not have sufficient funds now can and will be a vicious cycle of bad financial decisions. The immediate gratification of spending money you don't have is an addiction that ultimately leads to more debt. Deferring payments, making minimum monthly payments, applying for a second card, applying for a third card to consolidate the first two cards are common occurrences for developing bad financial habits.
Using a credit card to access capital is a smarter way to manage debt and your money. The terminology of "accessing capital" is business terminology. Therefore, borrowers should look at a cost-benefit analysis of the purchase of any products or services. This mindset changes everything on how to use a credit card, because you are applying the principle of leverage.
Leverage is the exact benefit of a credit system. After all, why would financial institutions and governments support a credit system if they did not benefit. Financial institutions profit off of interest rates, late payments, and other related fees. Governments benefit from tax revenue. Leverage teaches how to borrow $1 that is not your money and make a profit of $2. Then, payback the $1 you borrowed, and keep the other dollar. You spent none of your money, and yet made money.
In the credit card world, leverage can be found with rewards cards. Rewards cards give you something back in return for using the credit card. These rewards are usually either cash back rewards or travel rewards -- both function the same way.
In an ideal financially responsible world, here is how to leverage a travel rewards card:
Borrower pays for airline tickets. The tickets cost $1,000. The credit card rewards program says for every $1 you spend on traveling expenses, you receive 2 points. And for every 100 points you earn, you receive $1 towards traveling expenses.
The $1,000 flight ticket earns 2,000 points. This translates to $20 earned in travel rewards.
Borrower pays the $1,000 flight ticket in full by the due date, thereby not incurring any interest charges.
Borrower has leveraged $1,000 to yield $20 in travel rewards, and paid nothing for those travel rewards.
In a less-ideal example where the borrower pays interest on the amount of money borrowed, the question to ask is how much will it cost to borrow the money and what benefit does the product or service yield in return. Essentially, what is the tradeoff and is it worth it?
Borrower defers payments for $1,000 airline tickets. The interest cost to borrow is $200, and therefore the total cost of the airline tickets is $1,200.
Borrower makes monthly payments of $100 for twelve months to pay off the debt.
By paying the interest cost of $200, the Borrower receives the benefit of...? Arriving two days before Christmas, rather than on Christmas Day...flying direct rather than two layovers...buys a needed travel luggage with the funds that are available now?
In this last example, many mature financial experts will agree that this is stupid and wasteful spending, and the Borrower should not be using any credit card debt to finance their airline tickets. After all, this type of behavior leads down the path of more irresponsible spending and more credit cards which means more debt. In this example, I cautiously support it as long as you have a plan that includes a budget, a payment schedule, and a goal of what you are planning to accomplish by borrowing these funds. To do anything less than this would be characterized as financially irresponsible.
To play chess in the credit system is to understand that credit card debt should be viewed through the lens of a cost-benefit analysis. Needing an injection of funds to pay for things you cannot afford to pay-in-full is short-term thinking and inevitably leads to bad financial habits. While a rewards card doesn't come with 0% interest, the ability to receive cash back or travel rewards leverages your money by allowing you to borrow someone else's money and make that money, make you money.
Estimate credit card payments with this calculator.
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Great read. I have a couple of teenagers at home. What advice do you have for them regarding credit cards?