In the popular Netflix series "House of Cards," Kevin Spacey plays a character who builds a career by carefully layering one deception on top of another, much like someone building a house of cards. For too many American households, the tools of deception are not playing cards but credit cards, and it is the worst form of deception of all -- self-deception.
Last year, total consumer credit owed by Americans topped $3 trillion for the first time. Perhaps just as troubling as the level of this debt is the trajectory -- consumer credit outstanding has now increased for three consecutive years. This suggests that for many households, borrowing is not a temporary means to an end, but a permanent foundation of their finances. Basing your lifestyle on continually being able to borrow more means that you are building a financial house of cards.
How do you know if your household is overly dependent on credit? Consider whether you have experienced any of the following warning signs:
- You have carried a credit card balance for more than three consecutive months. Credit card debt is an especially expensive form of borrowing. While mortgage rates and interest on car loans are under 5 percent, the average rate charged on credit card balances is about 13 percent -- and can be considerably higher than that if you have some black marks on your credit history. Because it is so expensive, credit card borrowing should be viewed strictly as a short-term measure. If you owe a balance on a credit card for more than three consecutive months, you are not using this form of credit in the right way.
- You consistently make only the minimum payment on some credit cards. Paying no more than the minimum will leave you doing little better than treading water -- servicing the interest but not paying down principal. This plays right into the hands of the credit card companies, because it prolongs the period for which you will have to pay them interest on your balances.
- One or more of your credit card rates has been raised in the past year. Unlike mortgage rates, which rose for the first time in seven years, credit card rates were just about flat last year. So, if a rate was raised on one of your existing credit cards, it could be a sign that your credit standing is beginning to suffer.
- You have borrowed from your 401(k). Borrowing from a 401(k) or other retirement plan effectively robs from your future in two ways. It creates the illusion that you are saving for retirement when in fact part of your 401(k) balance is offset by a debt, and it robs you of the tax-deferred investment earnings you could be accumulating on the money you had to pull out of the plan to borrow.
- You have opened a new credit card account because you maxed out the limit on an existing account. It is troubling that some households measure their spending power according to their ability to obtain more credit. If you habitually open credit card accounts as a means of expanding your credit limit, you will eventually hit a wall where you can find no one else to extend you credit, and you will have an unmanageable amount of debt to pay back.
- Your debt level has increased for two years in a row. If you ever want to gain control of your finances, you have to adopt the mindset that all debt should be temporary. Most people go through periods of needing to take on debt, but if you are ever going to accumulate any household wealth then periods where you accumulate debt should be the exception rather than the rule. If you have seen debt grow for a couple years in a row, your household finances are headed in the wrong direction.
- You lack a plan for paying off all your debt. Credit card borrowing can be too easy. You can do it spontaneously, and unlike a mortgage, there is no repayment schedule for credit card debt. You should never borrow money without knowing specifically how you will pay it back. If you do not have a target date for when you will be debt-free, backed up by a realistic budget plan for how you will get there, then you do not have control of your household finances.
Remember, the more you build up your house of cards, the more painful it will be to take it down. However, if you do not base your lifestyle on something more substantial than borrowing, it will never be sturdy enough to last.