Wealth Building 101 – Credit Traps

Now that we have a basic understanding of debt and how it works, this segment will focus on credit traps.

My philosophy on debt is that there is really no such thing as “good” debt, just “acceptable” debt. However, there is indeed very bad debt, debt that can get you in real trouble. Today we will be discussing the worst kinds of debt that you should avoid at all costs.

Rent-to-own is probably the worst debt of all time. Basically, rent-to-own companies are playing the odds and preying on people who either have a profound misunderstanding of how finances work or have a questionable credit history, or (usually) both. It’s the worst kind of trap. These companies will allow you to “rent” their furniture, electronics, etc. at what seems like a low weekly rate. The way it works is that you go and select a TV or something that has a price tag of $500. The company breaks the “payments” into low weekly payments, like $20. At the end of one year you will own the TV, assuming you continue making the payments, but if you do the math, you’ve really paid for that TV twice over the course of the year! If, at any time, you get behind on the payments they send a couple of guys to your house to pick the TV up and you get nothing for the payments you’ve made. Then they can turn around and rent the TV to some other poor soul and the cycle continues. Because people who use rent-to-own companies are by definition living beyond their means, this is the most likely scenario. The companies are playing the odds and continue to churn this inventory for as long as they can and then ultimately liquidate it after it’s been paid for many times over. What a racket!

Another more common debt trap is credit cards. We discussed credit cards in the last segment so I won’t go into great detail, but suffice it to say that if you are carrying a balance on your credit card on a regular basis it is a yellow, if not red flag, that your finances will be in trouble soon. Credit cards are a good tool when managed properly, but very few people have the discipline to do this and often get into trouble with them. The thing about credit cards is that, not only do you pay interest (which is like throwing money off a bridge); you also get stuck with late payment penalties if you don’t pay on time. The credit card companies are very helpful with this – they’re happy to take the pain away by just tacking that late payment onto your existing balance. Now, you’re paying interest on something you got no value from in the first place. These can stack up very quickly and before you know it, you’re a slave to your credit cards!

Consumer debt would be the next in line of least acceptable debt. This is where you buy something by financing it at the store. A lot of stores have specials where you can buy something and either don’t make payments or don’t pay interest for a certain period of time (90 days interest free!) or both. An interest free loan sounds like a pretty good deal on the surface, but if for any reason you don’t pay the loan in full at the end of that period they go back and retroactively charge you for all the interest accrued during that period and continue to charge you interest until the item is completely paid off. Depending on your state usury laws, this interest can sometimes be as high as 25%!

There are other similar types of bad debt like buying cars from certain used car lots (generally, buying used cars at a regular car dealership doesn’t fall into this category), using store credit cards, etc. The best way to deal with these is not to use them at all. Sometimes this means making some sacrifices in your standard of living, but the alternative is much worse.

Assignment: If you do not have any of the debt I described today congratulations -- you get a free day today! If you do have this sort of debt I recommend that you make a (hopefully very short) list of these accounts and try to figure out what can be done about eliminating this debt as quickly as possible. In a future segment I will be discussing ways you can reduce your debt, but until then it helps to get a handle on just how much you pay for this sort of debt each month and how that relates to your income. Once you realize that you are becoming a slave to your debt, it can be extremely motivating to get out from underneath it.