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Credit Where Credit Is Due: Read This Before You Clip That Card

Posted: 09/02/10 12:58 PM ET

I'll be the first to admit it--as an advocate of thrift I've been all too eager to paint credit cards with a broad, tar-black brush. But I can admit when I'm wrong: credit isn't the enemy. Being broke is.

The two, of course, are intertwined in modern-day America. Not only will misuse of credit lead to brokeness, but a new study reports that rampant use of plastic is actually taking money out of the already thin wallets of the poor (generally cash-only consumers) and fattening those of rich credit-card users who rack up perks. Merchants can't afford to swallow the 3 to 5% per purchase fee that credit card companies charge, so it gets passed along to consumers, and is essentially subsidized by those who pay cash.

And the downsides of overdoing it on credit are severe: you end up owing your first born to a credit card company or foreclosing on your house... we all know the end results.

So I have been advising against any use of plastic, and was readying myself to hack my own cards to bits, when I spoke with Robert Spich, professor of Global Economics and Management at UCLA's Anderson School, and he set me straight: "Credit is neither evil nor good. It's all in the practitioners, whether you are borrower or creditor."

Essentially, if you are thrifty and money-smart, you can still use credit--and keep a clean conscience. Credit isn't necessarily the enemy of frugality.

This doesn't mean you should rush out and go on a plastic-fueled shopping spree. Living within your means is still the best way to avoid financial disaster, on a micro and macro scale.

But there is a right way to use credit and a wrong way. To paraphrase the NRA, credit cards don't destroy bank accounts, people do.

Says Spich, "If you use credit sensibly to make your life better, through smart consumption rather than immediate pleasures, purchases that improve your life into the future, credit can be a very positive thing." The key phrase there is "into the future." If you are using credit to buy something that will keep serving you for years to come--a car, say, or a washing machine--and will save you time, money, and headaches "that's when you look at credit as investment as opposed to consumption," says Spich. "There's a future payoff, a stream of benefits that flows from the purchase. So you don't mind making a monthly payment."

Investing wisely in your future (think college loans) makes good economic sense, and is a good use of credit. Of course, this doesn't mean you should buy a Mercedes on credit (no matter how much it might brighten your tomorrows) if your income level is more used Camry. Wise investment means balancing your various needs with your ability to pay--the longer it takes you to pay off the loan, the more you are paying for the purchase.

And don't break out the plastic for that fancy dinner or Disneyland tickets. Once they're consumed, they're gone forever...but that monthly payment isn't.

Secondly, if you are a saver, then you depend on borrowers (aka credit users) for that interest rate that makes your savings grow. A bank gives you, say, 2% interest on your savings, but lends it out at, say, 6%. They pocket the 4% and everyone gets something (it's also why bankers are richer than you). Credit, along with the bank's investments, is what makes a savings account a better place to keep your money than under your mattress.

Finally, credit is what makes or breaks your financial reputation. A good credit score will get you better loans, lower APRs, and enable you to ingratiate yourself to potential landlords. Want to buy a house someday? Good luck if you have bad or--just as bad--no credit.

By definition, explains Spich, credit is "the taking of a risk in another individual by lending them valued assets with the expectation that this lending would lead to increased economic activity and an increased capability of the individual who receives the loan."

Without a credit history, lenders won't know if you are a good risk or a bad one. The only thing that can give you a good financial reputation is having had debt and managing it well. Granted, most of us have the problem of managing too much debt, not too little. But the solution isn't abstaining from credit--it's using it wisely and paying it off.

Credit is an essential component of capitalism. We are a long way off from the general store and "I'll give you two sheep if you'll lend me your ram," but the basic idea remains the same. Credit allows our personal and shared economy to expand, and everyone should benefit, not just AmEx Centurion cardholders with 93 million reward points. It's all about awareness.

"By definition," notes Spich, "the rich are rich because they have better information, and therefore know how to use things in their favor."

Now you know. (You're welcome.)

 

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