The Use and Misuse of Credit Cards

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Unless you
have read the fine print of your credit card contract, here are
two facts you probably do not know.

  1. If you
    are on a trip, and you sign into a hotel using Card A, but
    you pay your bill with Card B, your credit in Card A to pay
    for your expected stay at the hotel is locked up until the
    next card payment period. To get it unlocked, you must tell
    the clerk to "remove the credit block" on Card A
    after you have paid your bill with Card B. Do not forget to
    do this before you leave the check-out counter.

  2. If you
    use a corporate credit card to buy anything, and your company
    then goes bankrupt and refuses to pay the bill, you are personally
    liable for 100% of the bill. You signed away your immunity
    when you signed for the card. Do not run up a big travel bill
    just before quitting the company.

In short,
read the fine print. When it comes to debt, know what you are
doing, and also what your creditor can do to you.

In this report,
I will pass along some other goodies that can help you.

If your children
are old enough to have a credit card but are not aware of this
information, you will be doing them a favor to forward this report.

HIGH
SCHOOL FOLLIES

College students
today are confronted with ads to get a credit card. They may run
up bills that they cannot handle. Parents will then be called
in to bail them out. No one in high school taught them the uses
and misuses of debt.

If I were
teaching high school, I would buy a pile of Texas Instruments
BA-35 Plus Solar calculators for student use in a class on consumer
economics. I would teach students how to use the I, N, PV, and
FV keys. A student who does not understand the use of this $20
tool is opening himself up for a lifetime of servitude.

This threat
did not seem great in 1959, when I took such a class. Credit cards
were then unknown to my generation. The credit card had been introduced
in 1950 by Diners’ Club. The initial client base was a total of
200 people, who used their cards in a total of 27 New York City
restaurants. American Express introduced a card in 1958. Its target
audience was travelling salesmen. In that same year, Bank of America
also introduced a card, later called VISA.

I can remember
receiving my first credit card in the mail in the mid-1960s. I’m
not talking about an application form. I was sent an actual card.
I tore it up. That was one of my better decisions.

Bank of America
made the credit card a mass consumption consumer good by sending
out 60,000 unsolicited BankAmericards, beginning in Fresno, California,
in 1958. Over the next 12 years, 100 million unsolicited cards
were mailed out in the United States. In 1970, legislation introduced
by Senator William Proxmire made this practice illegal. (Robert
D. Manning, Credit
Card Nation
[2000], p. 84.)

Bank of America
franchised the operation to other banks in 1966. Immediately,
Master Card appeared. Citibank got into the race. There was no
turning back. In 1996, the number of cards in the United States
was almost 1.5 billion.

You might
think that mass-mailing cards would lead to debt run-ups by people
who would then declare bankruptcy. This happened, but not at a
rate high enough to threaten the profitability of the credit card
industry. This cost was basically a marketing cost associated
with the creation of a mass-consumption item.

HIGH
RATES, HIGH RETURNS

A credit
card loan is a legally unsecured loan — a signature loan.
Thus, the likelihood of default is higher. Anyway, it was higher
until the new bankruptcy law was passed, making it illegal to
stiff the credit card issuer. The strongest chains of debt are
made of plastic.

An unsecured
loan is a high-risk loan. So, rates were high.

The public
became used to paying rates of interest above 15%.

People seldom
seek to change what they are used to.

A credit
card lowers the cost of making a debt obligation to practically
zero. It may actually be zero, net, because the risk of carrying
a credit card is less than the risk of carrying a lot of currency,
at least for legal transactions with after-tax money. When the
price of something falls, more of it is demanded. So, a lot of
people use credit cards. Most of them do not understand the erosive
effects on capital of a 15% interest payment.

Ignorance
is not bliss. It is expensive. In a fascinating chart on page
92 of Manning’s book, we see the history of the spread between
credit card rates of interest and the Federal Reserve’s rate for
overnight interbank loans. In 1980, the credit card rate was 17.3%.
The federal funds rate was 13.4%. This was at the height of Carter’s
inflation era, when the Federal Reserve stopped creating money,
allowing rates to climb. The percentage point spread between the
two rates was 4. A year later, 1981, it was 1.4, the lowest in
the credit card era. By 1984, it was up to 10.6. It dropped below
10 only once, in 1988: 8.8.
It was 11 in 2000.

For obvious
reasons, banks prefer to lend money to consumers who use credit
cards. The interest rate spread is high.

You can check
the average national rate for cards by clicking
here
.

Be aware
that this is the average. You can beat this rate. If you aren’t
beating it now, get to work.

Most consumers
do not know that they can negotiate a lower rate when rates are
falling merely by phoning the bank that issued the card. More
of them understand card-switching: paying off their debts on Card
A by signing up with Card B. But the savings may be temporary:
six months or so. Then Card B imposes new, higher rates. People
don’t read the fine print.

Now that
rates are rising, it is time to do whatever you can to get a locked-in
rate on your credit card. If you have procrastinated, it is time
to make a call to renegotiate your credit card rate. Here is what
you say to the person who answers the phone:

Hello.
My name is [ ]. I am a long-time customer, but recently, I have
received a letter from another card company that offers me a
much lower annual interest rate if I switch and pay off my existing
card. I have decided to switch, but I thought I should give
you an opportunity to lower my rate.

Save all
such solicitations for your files. This strengthens your hand
in negotiating.

If the sales
rep refuses to do this, ask for a supervisor. Sometimes lower-echelon
people have not been granted the authority to do this.

If you still
get no cooperation, use this
search engine
to locate a better card.

Before signing
up with a new card company, there are a series of questions you
should get answered. Read the fine print. If you still aren’t
sure, ask an agent. Here is
the list of 15 questions
.

If you are
tempted to re-finance your home to pay off a credit card, don’t.
The loan-creation fees will eat you up.

If you are
in so much debt on a credit card that you really do need to re-finance
your home, re-finance it for no more than you owe on your card.
Then tear up the card. You are not sufficiently self-disciplined
to carry one.

Immediately
go to your bank and switch to a debit card, where the bank issues
you no credit. You can use the debit card to spend only what you
have already deposited and have remaining after your previous
expenditures.

Banks do
not like debit cards and the skinflints who use them. Banks like
people who spend enthusiastically on their credit cards, run up
a huge balance, pay only the minimum monthly required payment,
and stay on the bank’s hook for a decade at 15%.

FREE
RIDERS

A free rider
is someone who benefits from a product or service but who doesn’t
pay for it.

A person
who buys a loss-leader at a supermarket but who then refuses to
buy anything else is a free rider. For instance, someone who buys
gasoline at Wal-Mart at a rate below wholesale is a free rider.
About 17 states have passed laws requiring Wal-Mart to charge
no less than the wholesale price per gallon. The politicians are
responding to Wal-Mart’s competitors. The losers are consumers,
as is usual for legislation.

Another example:
eating dinner at a restaurant that charges low prices in order
to get you into the building, where you will visit the bar. Just
don’t visit the bar. The low-priced food is a hook to pull in
crowds, who sit in the bar and drink. Avoid long lines by coming
early or coming on an off night. (I have known fundamentalists
who refuse to go to a restaurant that serves liquor. They do not
understand that people who eat there without buying any booze
are imposing losses on the restaurant, and if local churches organized
large dinner parties there, they might drive the place out of
business.)

A person
who uses a credit card but who then pays off his monthly balance
every month is a free rider unless the card requires an annual
fee, which most of them do these days. Even with a $25 fee, the
user is ahead. The card is convenient. He is using the bank system’s
vast digital network and recording system to make his purchases.

I am told
that people who pay off their monthly credit card bills on time
are referred to in the credit card industry as "deadbeats."

Why do banks
issue credit cards free of charge? Because (1) they think most
people will finally succumb to the temptation of spending beyond
their means; (2) cards reduce the number of checks written, which
are more expensive to clear and record than credit card entries
are.

For items
I purchase that I do not care who knows about, I use a credit
card. This is usually limited to gasoline, an occasional bag of
dog food, and books. I have no idea what my wife spends, but she
always seems to have enough frequent flyer miles to let her visit
her sisters in California.

I know a
woman who told her mother to charge her father’s funeral on a
credit card. The frequent flyer miles from a burial are high.
The hymn, "I’ll Fly Away," belongs in the planning stage
of every funeral.

TIPS

When you
get used to using a credit card, you tend to carry less currency.
If your credit card gets red-flagged by a programming error, you
can find yourself trapped in a store or, worse, on the road. If
you have one card, have one in reserve. The backup card should
have a low loan limit for safety’s sake.

Use the primary
card to track your expenditures. Use Quicken — warning: a
pre-2004 version — to categorize your expenditures. You can
see at a glance where your money is going. This is important for
budgeting and saving.

Write down
your credit card’s number and the bank’s toll-free number. Put
this in a safe place. You may need to cancel your card if you
lose it. This will help you get the right information to the bank.

Read your
statement every month. My wife monitors this with a vengeance.
She has caught overcharges and false charges. If you’re not sure
how to read your statement, click
here
.

Find out
in advance how good your credit is. Never negotiate a loan until
you know this for sure. If you don’t know, you will probably give
up too much. The higher your rating, the better your chances of
getting a lower rate. To find out where you stand, use the
credit-rating program here
.

Take steps
to insure your card’s privacy. Once your identity has been stolen,
you will find it a time-consuming mess to clear up the confusion
and restore your good credit rating. Here
are 15 tips to protect your credit card privacy
.

CONCLUSION

A credit
card is a tool. Like any tool it can make your life easier if
you know how to use it. But it can mess things up terribly if
you don’t.

Use it properly.
If you have any doubts, get a debit card instead.

July
7, 2004

Gary
North [send him mail]
is the author of Mises
on Money
. Visit http://www.freebooks.com.
For a free subscription to Gary North’s newsletter on gold, click
here
.

Gary
North Archives

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