As the recent economic crisis has shown us, there are dangers, obvious and hidden, associated with the abuse of credit.  Our economy, which is in large part based on the availability of credit, teeters on the brink of disaster.  At present, fifty cents of every dollar spent in the United States is charged on a credit card.  As a nation, our national debt has risen above $11 trillion.  Thousands of people are facing foreclosure and tens of thousands more are falling behind on credit card and automobile loan payments.  Now, maybe more than ever before, is the time to think about the dangers of credit.

Credit Creates An Illusion Of Wealth

Let’s imagine an average working couple.  Together, after taxes, they have an annual disposable income of $60,000.  That’s $60,000 per year to provide food, shelter, clothing, and to purchase needs and wants.  Let’s give our average couple two credit cards, one for his wallet and one for hers.  Assuming that each credit card has a $10,000 limit, we have just increased their spending power, as a couple, by $20,000.  We have, in essence, created $20,000 in spending power that did not exist on the day before we gave our couple their credit cards.  Our happy couple, instead of living off of $60,000, their actual income, can now, for a brief time at least, live off of $80,000.  We have given them the illusion of wealth – the idea that they have more disposable income than they actually have.

Credit Promises A Brighter Future

The credit system is dependent on two things: the ability of the lender to lend and the ability of the borrower to repay.  As long as these things happen, everything moves forward.  What happens, however, when the lender can no longer lend?  Or, what happens when the borrower can no longer repay?  We have a crisis, just like the one facing our economy today.

Let’s return to our couple.  Imagine that our husband, inspired by his friend’s new HDTV, decides that he too needs a new television.  He heads down to the local electronics store, plops down his new credit card, and is soon driving home with his brand new prize.  At the same time, across town, his wife is buying a new couch for the den.  Of course, in order to get her rewards points, she’s also using her credit card.  The both arrive home, happy as they can be, and they spend the evening cuddling on the new couch, watching the new TV.

We’ve just described a very typical, very normal series of transactions.  Clearly, there’s nothing wrong, inherently, in using a credit card to purchase the above mentioned items.  The real issue, the real danger, only becomes obvious when we take a deeper look into our couples’ finances.

Do to the availability of such good credit, our young couple haven’t given much thought to building up an emergency fund.  On top of that, because of their good credit scores, they have also decided to purchase a new automobile.  He wants to do the right thing, so they find a great deal on a new cross-over, with zero-down and low payments.  Total cost of the new car: $25,000.

Our couple, because of their incomes, can handle their monthly payments.  Sure, things will be tight, what with the new car and all, but they can make it.  Then the news comes.  The husband’s company is downsizing, and he has two months to find a new job.  After three months of looking, with very little luck, he takes another job, one which pays about two-thirds of his old salary.  This is when the problems really start to emerge.

First, due to the stress of the lost job, the bills have started to pile up, and our couple has had to pay a couple of late fees to their credit card companies.  Second, on more than one occasion, they’ve had to deal with over-draft fees at the bank.  Third, that new car, which just a few months ago was their pride and joy, has suddenly become a financial burden.  Unfortunately, they now owe more on the car than it is worth, and if they sold it, their friends and neighbors might know that something is up.  Afraid to death, they begin to argue more and more about money, and our happy couple isn’t so happy anymore.

For credit to be useful and have its proper place in the economy, borrowers must have the ability to repay their obligations.  Our young couple, who together brought home $60,000, now have over $25,000 in debt, he’s lost his job, and they have no money in savings.  They have nice, bright, shiny new things… but they have no money!

The scenario I have described to you above isn’t imaginary.  This is the reality that thousands, no millions, of Americans are facing, right now.  Overwhelmed with debts they cannot repay, people are worried, frustrated, angry, and depressed.  Who is to blame?  Sure, our couple should have known better than to buy such an expensive car, and maybe they should have waited a year or two before purchasing that new couch, but the money – or rather the credit disguising itself as money – was right there.  They believed, as most people believe, that their future income would pay for their past purchases.  Unfortunately for our young couple, and millions of other people just like them, the future isn’t always bright.  Life can throw some tremendous curve balls, and the pressure of being overextended can really slow down our swing.

Credit Justifies Impulsive And Irresponsible Spending

I can make the payments.  How many times have we heard this statement from someone who is trying to justify a particular purchase?  Is there anything wrong with purchasing a new television set?  No.  In fact, I have a nice, two year old HDTV sitting in my den right now, and I love it.  Is there anything wrong with buying a newer car?  No.  In fact, I just washed my wife’s van, which we purchased, slightly used, several months ago.  There’s absolutely nothing wrong with owning stuff, even new, nice stuff.  Problems arise when we purchase things that we cannot afford, based solely on the fact that we can make payments.

Several of my favorite personal finance bloggers use credit cards, but they use them primarily for convenience.  They never spend more than they can afford to spend, and they always pay their credit card balances off, in full, at the end of each month.  I cannot think of one writer who’s opinion I respect who would tell you to go out and finance a new car unless you had an adequate emergency fund in the bank and you were adequately prepared for a job loss or similar emergency.  I would suspect that even the biggest fan of credit card rewards points and credit card frequent flyer bonuses would suggest that credit can be dangerous when viewed as a solution instead of as a tool.

Our young couple would have been better suited to fully-fund an emergency fund, begin to live on a budget, and plan for their major purchases.  A year or two down the road, they could have paid cash for the new television, and really shopped around for the new sofa.  Perhaps, instead of financing a new car, they could have saved up a nice down-payment (or payment-in-full) and purchased a decent, used automobile, letting someone else take that depreciation hit.  When our husband lost his job, instead of arguing and worrying about money, they could really tighten their belts, use some of the money in their emergency fund, and given him an extra few months to find a job that he really enjoys doing.

Credit Can Be Beneficial

I almost ended this article with the previous point, but had I done so, I’m pretty sure that I can guess the types of responses it would have received.  There are those who would agree with all of the points above, but there are others who would point out a pretty obvious reality – credit can be beneficial.  So, instead of waiting for readers or detractors to point this out, let me be the first to agree – credit can be beneficial.

In certain circumstances, the availability of credit can makes things easier.  It’s easy to reserve a hotel room with a credit card.  It’s much more convenient to swipe a credit card than it is to walk around with a big wad of cash in one’s pocket.  Online, credit card transactions are processed instantaneously, facilitating the rapid purchase of goods and services.  There are those who are only comfortable when maintaining a rather large cash reserve in the bank, and these people would rather make payments on a car loan than be cash poor.  Without credit, millions of Americans might be shut out of the housing market, forced to be life-long renters.

I understand the role that credit plays.  I’m just saying, I think that role is too large.  We have become beholden to credit, and to the agencies that pedal it.  I think we have borrowed ourselves into a gigantic mess, and, unfortunately and unwisely, we are tying to borrow our way out of it.  It’s one thing to use a credit card to buy groceries, come home and pay your credit card off, and collect your rewards points.  It’s another thing entirely to max out that same credit card, overwhelm yourself with loan payments, and live without cash reserves.

The bottom line is, whether you use credit or not, you need a long-term financial plan.  This plan should be based on actual, real income and should take in to consideration that life doesn’t always move forward in a straight line.  You will face ups and downs, and abusing credit can lead to financial ruin.  If you must borrow, never borrow more than you can repay in a timely manner, and never extend yourself to the point that you are using credit simply to survive.  (Or, better yet, just roll with NCN, and live debt free!)

I’d love to hear your thoughts.  Have we overstated (or understated) the dangers associated with credit?  Does credit cause problems, or just reveal them?  Would we better off without credit?  Worse?  Leave your comments below.

My wife and I have been living without credit cards for four years.  For those who are ready to get out of debt, one of the first steps is to break the credit card habit.  You can’t fill the hole in while at the same time digging it deeper!  Here’s how we made the break -

We Balanced Our Checkbook -

This sets you up for success.  If you are going to live without credit cards, you need to know, to the penny, just how much money you have.  Grab your most recent bank statement, or go online and review your recent transactions, and balance your checkbook.

We Started To Live On A Budget -

You know how it works.  You go to the store, you see something you want, you swipe your credit card, and ten seconds later, you have new debt.  It’s just that simple.  What would happen, if between want and swipe, you had to think about your budget?  Trust me, that seven second pause, between wanting an item and using your credit card can save you so much money.  Instead of want and swipe, there’s now want, plan, save, and then swipe – with a debit card!

We Simply Put Our Credit Cards In The Back Of Our Wallets -

We didn’t cut up our credit cards or freeze them in ice water.  Instead, we just decided not to use them.  Frankly, we don’t miss them, and once we made up our minds, done was done.

We Created A Simple System For Life Without Credit Cards -

I’ve written about our system before, so I will not go into the details here.  Suffice to say, we have a system for managing our day-to-day finances, paying our bills, reserving a hotel, or renting a car.  Click the link to read more.

We Learned To Manage Our Cash -

I’ve heard it a thousand times – “If I have cash in my pocket, I’ll just spend it.”  That might be true, if you still have your credit card to fall back on.  On the other hand, if you knew, and I mean knew, that the cash in your pocket was all that you had, I’ll bet that you could learn to manage it.  We use the popular envelope system to manage our cash, but you can use any system that works for you.  The point is, we are were trying to break a habit, a habit that had haunted our marriage for almost a decade.  For us, going cold turkey and learning to manage our cash really worked.

I Stopped Thinking “I Deserve This”

I’ll leave my wife out of this one, because I’m the one who struggled with this.  In the past, I could justify almost any purchase by saying to myself – “I deserve this…”  It didn’t how much it cost, or how little we had, I could somehow rationalize the use of my credit card.  In fact, I can distinctly remember thinking – “What’s a little interest?  I work hard, I want it, so I’m going to get it…”  When I think back to some of the silly things I purchased, and how I justified those purchases, I feel so ashamed.  What was I thinking?  Better yet, was I thinking?  Now, instead of thinking – “I deserve this…” – I try to think – “Can I truly afford this…”

Breaking a habit can be very difficult, especially a socially accepted habit.  Let’s face it, most people use credit cards.  And, after you get out of debt, you might want to start using yours again.  There’s nothing wrong, fundamentally, with credit card use.  The problem is, use can turn into abuse very quickly.  I choose to live without a credit card, even though I know, that at this point, I could use one responsibly.  For me, I just don’t want to deal with the hassle of credit card payments.  So, I’ll just continue to roll with my debit card and cash.

If you are struggling with a credit card habit, there is hope.  Have a good long talk with yourself, embrace some of the changes mentioned above, and break the cycle!