Credit Card Debt Good or Bad?

by Apr 28, 2020Wealth

This is a simple question to answer; credit card debt is not only bad, but it is also terrible for you! Why is this terrible? Well, for several reasons. In no particular order, the first being the credit card’s interest is non-deductible on your taxes like a standard, a qualified loan would be. Interest rates on credit cards are excessively high and, therefore, unmanageable in a lot of cases. Banks are bombarding you with credit card offers with attractive upfront incentives making it extremely easy to take a new card and get that next thing.  

Let’s take a deep dive into each one of these topics to show you why this is not a good situation for you to be in.

Interest is Non-Deductible for Credit Cards

Mortgageshome equity loans, business loans, second mortgages, student loans, and others qualify for the interest to be deducted on income taxes. This theory implies that interest is tax-deductible. So what does this mean? It means that you can reduce your tax burden by a percentage of the interest paid on your income taxes, which is a tax saving. It is not a dollar-for-dollar deduction; however, it reduces the amount of taxes paid. This article is not about interest tax deductions and all the IRS jargon around this topic. This is to give you the idea that using a qualified loan allows for interest to reduce tax liabilities, which is good debt. Credit cards do not qualify for this treatment in the interest paid has no tax relief whatsoever. The negative for mortgages etc. is this is a secured debt, which means if default, the financial institution can take the asset back.  

Interest Rates on Credit Cards is Extremely High

The average interest rate on a credit card is 16.12%, which is a ridiculously high interest rate. This is a too high rate compared to other loan types. The average home mortgage rate is ~3.5%, which is about 12.5% lower than credit card rates. Other types of loans such as auto, line of credit, home equity, and others that all have significantly lower interest rates than credit cards. And remember the Federal Reserve interest rate is currently .25%. This is the rate that the banks borrow at which is almost 16% less than the average credit card interest rate.  

So Why is it the Default to use a Credit Card?

The simple reason is that credit cards are easy to obtain. You are probably getting bombarded from banks offering a new preapproved credit card. This means that you go to your mailbox and there is a credit card ready to use. Also, a lot of these offers have incentives like zero percent interest for six or twelve months, then going to the standard interest rate. Other incentives can be moving an existing balance from another card over with no charge and getting zero percent interest. Whatever the case, maybe you did not have to ask for a new credit card because it is in your mailbox. Simply put, the creditor is pushing credit cards because of the ease and profitability.  

So why do banks continuously offer a credit card, and how did they get my information? Let’s start with the second part of this question, how did they get my information. The credit bureaus sell credit report information to the banks. This is your credit score being sold from Equifax, Experian, and TransUnion to banks! Banks use this as an indicator of your ability to pay. The better your credit score, the more they want to offer you a credit card. 

Credit scores are built from payment history, the amount owed, length of credit history, and credit mix: the amount of credit card debt, home loan debt, auto loan or car loan, student loan, etc. This is the scary part because for an individual to make minimum payments on a credit card, make payments on time, and have these credit cards for a long time, builds that individual’s credit score. Banks use this credit score to target individuals for additional credit cards. Banks believe the better the credit score, the more cash flow an individual has to make the minimum payment. The analogy here is taking the kid to the candy store. People need the extra money, and banks give it out in the form of credit cards with very little in the way of requirements, just a good credit score. 

Now back to the first part of the question, which is why do banks and the credit card company continuously offer preapproved credit cards? Credit cards represent a considerable portion of the banking industry’s loan amounts and profits. To be more specific, Forbes looked at five US base banks and found that credit cards represent the third-largest amount of loan holdings. Couple this with the fact that interest rates on credit cards are generally very high, like 4 1/2 times greater than home mortgages, which indicates a huge profit pool for the banks.  

Even with bad debt from credit cards, this is a small amount compared to the profits. Also, credit cards represent unsecured debt, which allows banks to deduct the loss from their profits. This turns a bad financial situation into a win for the lender.     

Banks are like any other business. They have to make a profit year in and year out, and they have to increase top-line revenues for shareholder acceptance. A straightforward way of doing this for the banks is to push more credit cards because they have the highest interest rate of any loan investment. This is probably why individuals choose to use credit card debt vs. non-credit card debt and why banks push them so much.   

Credit cards are straightforward to secure, as for the most part, they only look at a credit score. A traditional loan vehicle requires extensive financial background information in which most individuals do not want to go through and or would be disqualified because of. Also, the credit score does not take into effect occupation, amount of income earned, and other factors that traditional loans consider before issuing. Banks know this and use it to their advantage.  

Credit card debt is a universal problem. Individuals making higher incomes also carry the highest level of credit card debt or credit card balance. Some of these individuals are making interest payments only, which keeps them tied to the lender. So credit card debt is not reserved for lower-income individuals but the reverse. The old saying the more you make, the more you want is valid. 

The best advice to follow is not to follow the norm. Pay down credit card debt as fast as you possibly can. If you have multiple credit cards, pay the highest interest rate first, and then work your way down, making the monthly payment on all cards. Also, factor in paying the smallest debt last as this will carry the least amount of interest from the balance. Credit card debt can consume individuals and put them in such financial difficulty they may never get out. 

Resist the shiny object syndrome and buy only what you need until you get yourself out of credit card debt! Definitely do not take out a new credit card and continue to buy as this will only repeat the cycle. As mentioned above, banks know that individuals will use credit cards at a high rate, which means individuals of those credit cards work for the bank and can for the rest of their lives. Also, avoid balance transfer to new cards for one time low rates. This just resets the clock and cost a fee to make the transfer.   

Debt consolidation is another way to attempt to fix the high interest rated of credit cards. By pulling all the debt together and refinancing with a home equity loan can reduce the total interest rate and allow for the interest deduction. If you find yourself in heavy credit card debt, some of the tactics may be needed to avoid debt snowball. This is when you are not able to service the minimum monthly payment.   

If you don’t have time to take care of your health, YOU WILL make time to take care of your illness!  What side of the equation do you want to be on?

Hello, my name is David Zaepfel. I blog about things that matter to you and try to break them down into simple and easy terms so that you can understand what is really going on.  I am a firm believer that simple is the best way to go.  Don’t overly complicate things as life is complicated enough without being bombarded with over the head talk.  Keep it simple!  Let me know what you think.

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