The use of credit is not a phenomenon born in recent times; it dates back to the dawn of civilization. Aside from the ability to swipe, tap, or send instant payments, not much has changed. Now, just as then, the proper use of borrowing can play a strategic role in the financial success of individuals, corporations, and even empires. However, if it is not used wisely, it can be a sinister trap, becoming a prison of the debtor’s own making. Over time, lenders have refined and arguably perfected the art of ensnaring unwitting prey, enriching themselves at the expense of their clients.
The Degradation of Lending Standards
In ancient times, long before paper and pen, there are recordings on clay tablets showing the borrowing and payment of gold and silver coins. In these times, money lenders, who predate modern banking institutions, would accept deposits, pay interest to the depositor, and lend money to those in need at a higher interest rate. They would pocket the spread between the two rates as just compensation for managing the payment and collection of sums due.
These ancient money lenders were extremely shrewd, having become money lenders themselves through the wise management of their own estates. They were very careful about who received loans, why a loan was needed, and whether the borrower had the ability to repay it. If they thought a venture to be unwise, they would freely explain their reasoning. In such cases, they would require collateral that exceeded the value of the loan itself in the form of jewels, gold, or deeds to property.
Banks, over time, were formally adopted and assumed the role of the lender. There are several cases of imprudent lending throughout history, mostly caused by lending more than the bank had the ability to cover. Since it has always been extremely rare for depositors to claim their funds all at once, this practice enabled banks to overextend themselves until something spooked the depositors into wanting their funds in hand—be it war, famine, or general distrust of the system. These bank runs would force the liquidation of the bank and provide little protection to those requesting their funds after the vaults were dry.
In the United States, until the 20th century, gold and silver played an instrumental role in backing the currency, making the overextension of lending much more difficult for banks and limiting the amount of borrowing by government. It acted as a tether or leash to keep both the banking system and government in check.
The creation of the Federal Reserve in 1913, coupled with Franklin D. Roosevelt’s Executive Order 6102 in 1933, banning the private ownership of gold, together laid the foundation of the corrupt modern banking system, devoid of any sense of morality. This vile establishment is happy to lend—in the form of credit cards, auto loans, student loans, and mortgages. Since government has historically bailed them out and now guarantees most mortgages and student loans, the incestuous relationship of the two ensures that the banks get paid at the expense of the borrower or the taxpayer. One way or the other, they will get their pound of flesh.
Avoiding the Trap
“If you don’t know the rules—don’t play the game.”
It is a regrettable truth that in today’s society, most people have the unwavering propensity to do two things: They will increase their expenses to equal that of their income, no matter how much they earn, and they will overextend their earnings for instant gratification, satiating the desire for whatever it is that they want in the moment. They cannot be blamed for this, as it is in our nature to do exactly those two things.
While it may seem natural for one to feel they deserve more based on a promotion or increased salary, it is the cheese on the trap and is exactly what the system depends upon.
The system was developed to take more and more future wealth out of your pocket before it is earned. The author would advise against giving in to base instinct and putting off the extension of credit until savings have been established from the rise in income.
An Example of Overextension
Someone gets a new job or a promotion, and they buy a bigger house, new car, etc. What was previously unattainable is now committed in the form of higher mortgage and auto debt. If the person then loses their job and does not have the savings to cover the payments, the detriment of the situation has been amplified.
While it is convenient to use credit cards at the grocery store, the gas pump, and at retail locations, care must be taken to avoid the pitfalls of revolving credit. It may not feel like you are actually spending your own money, and it is easy to spend recklessly. This is not a fault in the system; it is by design. Credit card companies are very patient and are betting on the odds that you will eventually miss a due date and/or carry a balance forward at some point.
If you are struggling to make regular payments on your loans and credit cards, the first step is to stop using credit.
“If you find yourself in a hole—stop digging.”
The fees and interest rates for balances not paid month to month can be devastating and will continue to bury you deeper and deeper if you continue adding to the debt burden.
Use the System for Your Benefit
There are several ways that credit can be used as a beneficial mechanism. With the money saved or earned, one could use it for profitable investment, thereby compounding their earnings, or possibly fund a business venture that supplies a steady stream of passive income in the future.
A farmer who borrows for seeds and fertilizer can settle the debt at the end of the annual harvest and have a hefty sum left for themselves. They effectively used credit to earn a healthy reward.
A seasoned real-estate investor can take a commercial loan against an apartment building, whereby he or she receives significantly more every month in rents than the cost of the principal and interest on the loan. The tenants are paying off the loan, allowing the extra cash to be used for maintenance, upgrades, or to fund another real-estate venture.
A business owner gets a loan at an annual interest rate of 10%. The loan is used to procure additional products that they would otherwise be unable to purchase. With the knowledge that they will easily cycle through the entire inventory in less than one year, at an average profit of 30%, they are earning revenue that would have otherwise not been possible. Furthermore, the interest on the loan would be a valid business expense, thus reducing their tax exposure and increasing the margin.
Making Credit Cards Work for You
Credit cards can also be a great benefit if used properly. The key to ensuring that you do not get caught in the credit card web is to pay the last statement balance before the due date. Whatever the balance was at the date of the previous statement is what is due by the due date—not the entire balance on the card. Doing this ensures that all purchases are exempt from interest payments, as credit card issuers provide a grace period on purchases.
To expound upon the subject, those with good credit should qualify for cards that offer no annual fee and provide 2% or more in cash rewards. Cash-back rewards are not treated as income and are exempt from taxation. Those with significant business expenses would benefit most from this strategy, as the grace period provides them with extra time to pay while earning a couple of percent along the way.
Due to the grace period of credit card transactions, another strategy is also quite effective. Instead of making a cash or check purchase, put the expense on a credit card shortly after the billing cycle has ended. Take the money that is owed to the card and purchase a 30-day Treasury bill or CD at your bank. The billing statement will not be generated for several days—up to 25—and the payment will not be due for 25 days more.
The interest earned during the 30-day window can be added back in with your next monthly contribution and be compounded indefinitely. If the card that you used also has a cash-back reward, the cash back could also be included in your compounding T-bills or CDs.
The process would seem tedious in the beginning, but through the magic of compound interest, the rewards down the line could be substantial.
Every item is different. The most reliable way to understand what you have is through an in-person evaluation.