(12 of 14) Chapter 11 of Money and Wealth: What You Shouldve Learned as a Teen, Book 2 (Formatting mostly lost on Facebook) ************ CHAPTER 11 CREDIT AND DEBT “He that sells upon Credit, expects to lose 5 per Cent. by bad Debts; therefore he charges, on all he sells upon Credit, an Advance that shall make up that Deficiency.” Benjamin Franklin, Poor Richard’s Almanack, 1737 Credit offers you the opportunity to go into debt... ...And debt is slavery. Why slavery? When you owe money, you have to work to pay it off. You cannot live a life free from work. Nor are you free to work to make money that you are free to spend as you wish. So credit and debt are two sides of the same coin. For most people, credit comes in the form of credit cards. Let’s look at the idea of credit cards more closely. On Silver Island, people trade goods and services using paper money. For example, two people transact business without a third party being present. Zane, a farmer, needs tools, and trades paper money with Lori, a store owner, for those tools. However, Jon, a goldsmith and banker, observes them and thinks, “There has to be a way I can make money on their transactions.” Jon has an idea. He creates a little card that says, “Jon’s Credit Trust & Savings.” He gets approval from the local council by explaining how it would be in everyone’s interest to allow easy credit. Jon reminds them how much value the community got from aqueducts and other public projects that benefited everyone. Why not let individuals borrow, with a small interest rate, so that they can have more flexibility in their lives? Good idea, right? So Jon offers his little card to people saying, “Hey, you don’t have to have money to spend money. If you need something now, you can pay later, plus a small fee. And if you pay it off within a month, you don’t have to pay a fee.” The idea catches on. Some people use the card and are smart enough to pay it off at the end of each month. Others see the fee as small and so they don’t mind paying a little extra. People are still transacting in the same way, but a little bit of each transaction starts filling Jon’s pockets. Over time, there is some fraud and abuse, and non-payments, requiring Jon to hire debt collectors. He has to raise the interest rate on the card to cover the difference. But that’s fair, right? The costs are spread among everyone, so the increase is small. All of this sounds good until you realize where it is all headed. Originally interest rates were about 3%-5%. But when banks and financial institutions get greedy and hand out cards to anyone and everyone, what happens? Remember when you were in college and credit cards began showing up in your mail? Easy credit, right? Even though you didn’t have a job? Some people didn’t pay them off and got bad credit. But as we have learned... TANSTAAFL There Ain’t No Such Thing As A Free Lunch. Someone always pays. So now we have interest rates routinely over 20%. Credit cards, especially those that offer minimum payments that barely cover the interest rates, are designed to enslave you. How? By stimulating your desire to get things now, rather than wait for when you have the money. Then by offering a minimum payment that covers the interest, the amount you owe remains the same. You are still on the hook for paying the interest without having paid anything on the principal amount you owe. People who extend you credit are less interested in you paying off the debt. They’re more interested in keeping you in debt just enough so you can make the monthly payments. Imagine you are the creditor. You have 100,000 people using your credit cards. Ideally, they have reached their credit card limit (their debt ceiling) and are making only the interest payments. You have a steady and massive income while everyone else works hard just to pay the interest. All because you convinced them that credit (that is, debt) is a good thing. And if someone has enough money to pay more, reducing the principal, then what do you do? You offer to raise their credit limit, so they can spend more, get more in debt, and have a higher minimum payment. Debt is slavery. The whole point is to keep you paying. That’s why credit card companies are less interested in how much debt you have. They want to know if you can make the monthly payments on time. If you can, you are a good customer. Remember how they taught you in school to save money, buying only when you have saved enough money? They emphasized frugality and thrift? No, you don’t remember that? Did you have to look up the definitions of frugality and thrift? Frugality means being careful about spending money, or not using things thoughtlessly so that you don’t have to spend needlessly. Thrifty is similar, being careful about money management, saving for a rainy day, and avoiding debt. More likely, schools taught you simple things about opening a checking account and building credit. How important it is to pay on time. How to at least pay the minimum payment. How to protect your credit rating so you can get loans. In other words, they taught you, not how to be free, but how to manage being enslaved to debt. When you buy a home, you will find something even more extraordinary, something called APR, and lots of talk about monthly payments over 30 years. When buying a home, how often do you see the payment schedule? Suppose you buy a $300,000 home at 7% interest over 30 years. If you look closely, you will see that the first few years of payments are almost all interest and no principal. This means that you are paying just the profit that goes to the lender, not significantly paying down the actual loan. After a few years of paying, you will still owe over $290,000. If you stay with their payment schedule, your $300,000 home will cost more than $1 million. In other words, the lender gets all of their profit up front, with you still owing almost the full amount. And what if you get talked into a variable interest rate or a low interest rate for the first three years that goes up the fourth year? You find out quickly that lenders start working hard to get you to refinance. Lower your monthly payments, and start at $300,000 again. Suppose you have made payments for decades and you owe less than $150,000. You now have equity. When you have equity in your home, you have built up inherent value that you can use. Equity is the difference between the value and what you owe. For example, if your home is valued at $300,000, and you owe only $100,000 on the mortgage, then your equity is around $200,000. You could take out a second mortgage for as much as $200,000. Generally such second mortgages are used to improve the home, or solve some immediate financial need. Lenders regard an equity loan as safe because you have no choice but to pay it back one way or another. In other words, if you cannot make the payments, they take your home. Isn’t that nice? When it comes to home ownership, you should pay for the home outright, or you should rent it for more than the payments. Or if you want to live in it with a mortgage, be sure to have the money to pay down the principal in those first ten years. Pay extra payments that apply to the principal only. You can knock several years off the mortgage and save tens or even hundreds of thousands of dollars in interest. Remember, if you learn nothing else from this little book, learn this. Debt is slavery. Let’s explore what can be done to invest thoughtfully in a world that loves debt. ************ markandrealexander/
Posted on: Sun, 28 Dec 2014 00:35:19 +0000
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