A year ago I gave myself a goal to stop making interest payments on credit cards. I have to admit that it never really dawned on me that making interest payments on credit cards is like paying more for every single product you buy on it.
Something else occurred to me – people tend to use credit cards to buy stuff that they can’t afford at the current time, and then make payments on it later. This is fine if you really need something immediately and you know that in the long run, you will be paying more for the product through interest payments. However, a lot of people use them to live beyond their means in the hope that tomorrow they’ll be making more money. This cycle continues, because when they make more money their credit limits go up, and they live further beyond their means.
However, credit limits exist for a reason. They don’t allow you to live infinitely beyond your means, because some people just can’t stop themselves from spending. They allow you to spend a dollar/pound/yen amount over your means, literally your means plus some fixed amount. However, you end up paying back more than you originally spent because of interest, so over time you are effectively living below your means!
Imagine you decided to have a really frugal year and you put all your extra money in a savings account. When the year is up, you continue using your credit card as normal for purchases, but you pay off your card every month using your savings account, thus accruing no interest. Everything you save on interest goes back into this savings account. You can spend within your means plus the contents of your savings account. Your savings account doesn’t empty because instead of a portion of your salary going to credit card payments (including interest), it gets paid into your savings account. Essentially you have become your own lender, and as a result, you don’t make any interest payments! Not only that, but the bank will actually pay you interest because of the money in your account. As a result, after one frugal year, you have more spending power than the person on the credit card. You also maintain good credit scores because of the constant use and good payments of your credit card.
So why don’t all people do this? Because people prefer to live for now and not for next year. Because credit card companies advertise that taking on debt is good (just look at MasterCard). Because credit card companies feed off hard times by increasing their interest rates when people are struggling to pay. Credit cards are seen as the normal way to spend, when in fact they should really only be used as tools to access money you already have, and for strict emergencies.
The same is true of mortgages – imagine that your parents are wealthy enough to buy you a house, on the one condition that you save to do the same for your kids. As a result, no one in the family (as long as the chain is not broken) ever has to make interest payments on a mortgage! The family through generations can even share an account to put surplus money into, so that if one generation hits hard times, the chain will not be broken. This is actually not a big secret – wealthy families have been doing this for many generations, and it’s the lack of interest payments that helps keep them wealthy.