A dozen years ago one of my best friends was dating a German fellow. When he first came to Toronto, he commented to my girlfriend that the people in Toronto appeared far richer than the Germans.
“Why do you say that?” she asked.
“Well, everyone here seems to drive nice new cars and that costs money.”
“Right, but you can lease a new car and drive it off the lot after putting about $1,000 down.”
“What?? Why would the car dealer give you a $50,000 car with only a payment of $1,000?”
That concept was foreign to him. In Germany, if you drive a nice car, you generally paid the full $50,000 for it. How many nice cars would any of us be driving if we had to pay full price for them up front?
Easy credit fosters business growth. Imagine how well the car dealers in town would be doing if everyone who went to them had to pay full price up front for the car they wanted. Many of them would go bankrupt. But credit has a downside. The objective with credit is to balance the ease of obtaining a loan with intelligent lending practices and adequate capital. Without that balance, disastrous consequences can arise as we saw with the collapse of Lehman Brothers in 2008.
Applying the principal of balance to our personal lives is challenging. When my in-laws were young, there were no credit cards. If you wanted something you saved for it. You did not get it until you had the money to pay full price, then you fully owned it. Hence if you wanted to take a vacation, you saved up the money ahead of time. If you wanted to buy a trailer to tow behind your car, you saved up the full amount ahead of time. The only exception back then were mortgages, and most people of my in-laws’ generation hated the thought of debt. So did the bank managers, so the percentage mortgages on offer were conservative, never more than 65% loan to value.
Nowadays, things are different. Canadian lenders typically permit you to borrow up to 80% of the value of your home in a mortgage. They also provide credit cards to people they shouldn’t. I have recently seen an 85-year old woman with Old Age Pension and Guaranteed Income Supplement as her only income being offered a $13,000 credit card limit. That person has no ability to repay the debt. With lending practices that loose, defaults are inevitable. The business rationale is that the 98% of people that will pay their credit card debts will compensate for the 2% that won’t, and the banks will continue to make money given the 20% to 30% interest rates being charged.
Over the past holiday season, debit card companies paid for advertising to demonstrate that if you pay for Christmas purchases with a debit card as opposed to a credit card, there is no pain after Christmas. Another suggestion is to set aside in cash what you have to spend and stop buying gifts when you are out of cash. These are good ideas that take you halfway there. The other half is having the discipline to follow your plan.
The Canadian trend is clearly away from cash and to debit and credit cards as the payment methods of choice. “I never have any cash on me” is a frequent refrain in hockey rinks across the country, and businesses that only take cash are severely limiting their growth prospects. Nonetheless, it is likely an eye-opening exercise personally to take a month and only pay for things with cash. See if that causes you to change any of your buying behaviours. You may find that it is far harder to fork out $200 in cash for a cut and colour or for some clothing than it ever was when you put those purchases on debit or credit. Cash is real; cash creates a direct connection with the bargain you are making; and when cash is gone, it is gone.