The Pain Of Paying Cash
| September 8, 2008 | Posted by Roshawn Watson under Uncategorized |
By: Roshawn Watson
Forcibly Curtailing Our Debt
In an effort to mitigate losses, lenders are concertedly diminishing consumers’ abilities to borrow (lowering credit limits and imposing stricter credit worthiness criteria). After banks began coming under fire for reckless lending practices and suffering tremendous losses, banks issuing credit cards have finally began to more responsibly evaluate consumers ability to pay back loans. Other lenders have also done the same. Accordingly, mortgages and student loans are becoming increasingly more difficult to obtain.
Flawed Thinking Is How We Got Here
The increased media coverage on the U.S. economy has caused many people to ask “how did we get to this point?” Although its convenient to lay the entire blame for the current state of the US economy at the feet of irresponsible and greedy lenders, the truth is there is shared blame for the current credit crunch.
At some point, we have all had flawed thinking when it comes to money. I remember my own idiotic views about “smart” credit card spending years ago. Fortunately, someone called me on my blatant ignorance before I could do too much damage although it did take me months to clean up the mess I created.
Like me, millions of Americans simply thought about money incorrectly. We we borrowed our way into financial bondage because somehow we got it in our heads that we were suppose to have things we couldn’t yet afford. “After all, we worked hard and have earned it!” Consequently, as of 2007, our debt-to-income ratio was recently at an all time high of 19% (Smart Money, September 2007).
We have used debt to subsidized lifestyles that we could not afford for so long our whole “money psychology” is flawed. Instead of evaluating total costs, we are willingly conditioned to only consider whether we can afford “small” payments.
Cash or Credit?
Available credit has distorted the psychology of consumers to the point where individuals are willing to pay significantly more for items laterin order to delay the pain of payment. For example, it is a fact that even consumers who pay their credit card balances in full each month (often referred to as deadbeats) will often end up paying more than their cash-paying counterparts. According to Dun and Bradstreet, consumers spend 12-18% more when making credit card purchases compared with those who pay in cash. Even a 5% cash back bonus can’t compete with the “discount” of paying cash.
Not only can one often get better deals by paying cash, one also will limit purchases if he knows it is coming out of his bank account today.
The “pain of paying” cash serves as an effective deterrent against overspending.
In his book, Predictably Irrational, Dan Ariely argues that credit puts a buffer between the “ecstasy of consumption and the agony of payment.” Thus, as credit becomes more difficult to obtain, more people feel the pain of spending and therefore limit their purchases. In effect, there is a shift back to evaluating the true costs rather than the monthly payments. That’s because if the money has to come out of your account now, you think about the costs now. It is no wonder why consumers are feeling the sting like never before as credit becomes more difficult to obtain and awareness of the credit crunch increases.
Big Implications For The Economy And Individual Consumers
Perhaps one of the more prominent examples of how tighter criteria affect consumers at large is the current housing crunch. In 2007, forty-five percent of first-time homeowners put no money down and the median first-time home buyer financed a whopping 98% of the purchase. However, as no money down mortgages became scarce, home prices began dropping faster than during the great depression. The shift was so dramatic that it crippled mortgage giants Fannie Mae and Freddie Mac and any other lending company with business models based on our flawed spending habits. In order to bailout these lenders and prevent yet another blow to an already hemorrhaging US housing market and economy, the Treasury recently seized control of the companies.
Blessing In Disguise?
Overall, more responsible lending practices are good things. Although a voluntary change in consumer spending habits would be more meaningful for individual growth (i.e. this is similar to hiding alcohol from an alcoholic instead of sending him or her to rehab), restricting how much damage we can do is not only sound but should have been done years ago. Our increased awareness of the total costs will hopefully breed better financial decisions in the future by at least somewhat limiting the financial damage that we can do.
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Good points as usual.So…lenders are making it increasingly difficult for borrowers to establish new accounts and lowering credit limits on existing accounts to prevent further damage. I wonder what percentage of people are seeing significant credit card limit slashing as you reported back in June? Particularly since you also reported back in June an increase in credit card usage as the economy declines. It seems people are determined to see their way into debt one way or another.
Thanks financial dream. You have some awesome comments. Consumer borrowing has finally started to decline somewhat. In fact, it is the lowest it has been in seven months (see reference).http://money.cnn.com/2008/09/08/news/economy/consumer_credit.ap/index.htm?postversion=2008090815Interestingly, debit cards are becoming very popular again. Their use is up about 16%Friendly regards,SW
I use credit for one thing: To build a positive Reputation of Borrowing Fitness.I don't buy anything unless I can pay for it up front, with cash. Granted, I don't have the scratch to buy a house or a car, so I'd need to take out a loan for it someday. How do I convince a lender to let me borrow money when they have no idea who I am? Paying with cash only, all the time, only maintains your status as a ghost to these people. The problem was, I used the cash method all of the time. When I went to buy a car as a young man in my mid-twenties, I had to have a parent cosign because I had zero credit history. I had shot myself in the foot early on in life.So now I use my credit cards like I would a debit card: If I want to purchase, say, a television, I take the money I would've paid in cash for the television and put it in a separate account, then buy the TV on credit. Since effectively I no longer have this money anymore (I just assume it isn't there in the other account and don't touch it), there's no way I'll allow myself to buy more things with it since I won't have the cash to back it up. Then, I pay the credit card bill out of the other account.Granted, I have to calculate interest in there, but if I make way more than the minimum payment (pay it off in three months, perhaps), I minimize the blow of taking interest on the payments.So, with that method, I get the best of both worlds: Rolling payment history with no slow pays or defaults, and a minimal amount of debt to carry around. The more this happens, the higher my score, and the higher my score, the lower I can push my interest rates since I'm less of a risk.Interest sucks at first, but keep this in mind: You don't earn credit. You buy it. You're basically purchasing the privilege to have a lender say "yes" when you ask them for money somewhere down the line.
I use credit for one thing: To build a positive Reputation of Borrowing Fitness.
I don't buy anything unless I can pay for it up front, with cash. Granted, I don't have the scratch to buy a house or a car, so I'd need to take out a loan for it someday. How do I convince a lender to let me borrow money when they have no idea who I am? Paying with cash only, all the time, only maintains your status as a ghost to these people. The problem was, I used the cash method all of the time. When I went to buy a car as a young man in my mid-twenties, I had to have a parent cosign because I had zero credit history. I had shot myself in the foot early on in life.
So now I use my credit cards like I would a debit card: If I want to purchase, say, a television, I take the money I would've paid in cash for the television and put it in a separate account, then buy the TV on credit. Since effectively I no longer have this money anymore (I just assume it isn't there in the other account and don't touch it)
Very interesting article. I suppose the think about paying cash is that it can be inconvienent to use. Using cash means going to the ATM and withdrawing cash then it means always having cash in your wallet. For a lot of people this would be too much but I think that using cash is one of the most effective ways of curtailing personal spending. The most effective way is to simply leave your wallet at home 🙂
thanks for the comments! Until Death do Us part. I agree cash is inconvenient. I personally almost never carry cash per se. I use my check card as cash. Since it is still coming out of my account, it still serves as a deterrent for me.
Very interesting article. I suppose the think about paying cash is that it can be inconvienent to use. Using cash means going to the ATM and withdrawing cash then it means always having cash in your wallet.
For a lot of people this would be too much but I think that using cash is one of the most effective ways of curtailing personal spending. The most effective way is to simply leave your wallet at home 🙂
Shawn, this is a good post. Brings to mind a favorite saying from an old friend "Paying cash only hurts once"
Thanks so much for an awesome quote and for your comment!
Shawn, this is a good post. Brings to mind a favorite saying from an old friend "Paying cash only hurts once
My recent post Centavos Dividend Portfolio: Uptrend Update
Good points as usual.
So…lenders are making it increasingly difficult for borrowers to establish new accounts and lowering credit limits on existing accounts to prevent further damage. I wonder what percentage of people are seeing significant credit card limit slashing as you reported back in June? Particularly since you also reported back in June an increase in credit card usage as the economy declines. It seems people are determined to see their way into debt one way or another.
Thanks financial dream. You have some awesome comments. Consumer borrowing has finally started to decline somewhat. In fact, it is the lowest it has been in seven months (see reference).
http://money.cnn.com/2008/09/08/news/economy/cons…
Interestingly, debit cards are becoming very popular again. Their use is up about 16%
Friendly regards,
SW
My recent post Is it Possible To Live Without Debt?
Thanks for the comment!
Until Death do Us part. I agree cash is inconvenient. I personally almost never carry cash per se. I use my check card as cash. Since it is still coming out of my account, it still serves as a deterrent for me
Thanks so much for an awesome quote and for your comment!
My recent post Is it Possible To Live Without Debt?
You usually takes good thing about these financing options after meeting the pre-requisites in the lenders.
We would really like to assist our customers to correct their
financial problem as quickly as possible.