We live in the age of credit; new phone, new car, you name it and it’s financed. Gone are the days of saving for what you want. Yes it’s the age of instant gratification and let me explain why this is making you poor.
Investopedia defines credit as a contractual agreement in which a borrower receives something of value now and agrees to repay the lender at some date in the future, generally with interest. Investopedia defines a credit card as a card issued by a financial company giving the holder an option to borrow funds, usually at the point of sale.
So let’s get something straight, this small piece of plastic by definition inhibits your ability to manage your money while simultaneously reducing your wealth and enabling you to live above your means.. what ever happened to ‘responsible lending’?
So how does this directly inhibit your wealth? Not only are you by definition living above your means, but you are also no longer accountable for your money, why? Because you’re not feeling or seeing the money being spent which is why each week I withdraw my entertainment budget in cash so I can see and feel the money I’m spending, it enables you to be more accountable and you’re more likely to question how you spend your money and what things you really need to purchase.
In addition to this, owning a credit card also decreases your ability to borrow money. Even if you pay off your credit card each month the bank will look at the limit of your credit card and say that you have the potential to get into that amount of debt and so they add this amount into your liabilities and monthly expenses, both of which limit your borrowing capacity.
It is also easy to overspend with a credit card as most people have a limit that exceeds their monthly income so if something goes wrong you’re at risk of not being able to repay this, which can affect your credit rating and your ability to borrow in the future.
Now some people will argue that there is such a thing as good debt, yes good debt is debt against an appreciating asset, but let’s be honest how many of the purchases you make on a credit card or on finance are for an appreciating asset?
So what is the first step to building wealth? The first step is knowing how to budget and understanding where your money is going. Most people are of the view that if they earn more they will save more when in fact statistically you save more on average when you earn less, and this is because if you’re in the habit of spending what you earn this habit will remain irrespective of what you earn meaning you’ll end up spending more simply because you have more to spend and that is the very definition of being broke. Wealth is created in the gap between what your expenses are and what you earn, the aim is to increase this gap.
So where do you start? Let’s take a look at your phone and your car. You may not realise but by getting the latest smartphone each year with your phone plan you’re actually financing your phone.
Yes $89 per month doesn’t seem like a lot but when its over 24 months that equates to $2,136 and yet had you purchased a brand new smartphone for $1,200 and taken up an unlimited $22 per month phone plan like I have with Vodafone, your total cost over 24months would be $1,200 for the phone and $528 for the phone plan, totalling $1,728 which has saved you $408. With $408 you could have gone to three fine dining restaurants if not more with that money or purchased half a trip to Bali through Groupon with that money.. I know which one I’d choose.
Now let’s take a look at your car. Yes driving a shitbox sucks and having just done it for a week while my car was being repaired I feel your pain but the fact of the matter is if you can’t afford it in cash then you shouldn’t be buying it.
Not only do car loans reduce your borrowing capacity when you want to buy a property but they also increase your expenses so that gap we mentioned where wealth is created, you’re actively decreasing it.
If you’ve even purchased a car you’ll remember the first two questions you’re likely to be asked, “how much are you looking to spend?” and “Are you looking for finance”? Seems innocent. The reason behind asking if you need finance is for one thing and one thing only. Commission.
Car loans often work differently from home loans whereby banks don’t pay commission on car loans. What does that mean? That means that how brokers, bankers and dealers make money is by loading their commission (between 10 to 20 per cent of the purchase price of the car) onto your loan, which they often don’t disclose. Say What?! Yes we all need to make a living but let’s be upfront about it!
What’s worse than this and yes it does get worse, not only are you paying 10-20% of the purchase price of the car in commission, but because this is loaded onto your loan, yes, you guessed it, you’re paying interest on this as well! It’s the gift that just keeps on giving.
Now if you’ve gotten yourself into a bit of mess with your finances it’s simple enough to get yourself out of it, the first step is to write down absolutely everything you spend money on, even it it’s 50 cents, then you need to make a list of the expenses you have and only keep the necessary, and a list of debt you have and how much your repayments are on this. Then you need to work out your income and of course look at ways you can reduce your expenses.
If you’ve gotten yourself into a bit of credit card debt that you wish to get out of and can’t afford you can call your bank and request a copy of your contract under a section of the Act in which the bank has 30 days to provide this to you. Most financiers were a bit slack at issuing contracts for credit cards so it gives you a leg up in negotiating what is called a settle for less arrangement whereby you agree to pay the bank a lesser amount of what you owe them and if they also agree you will be able to get some of your debt wiped without affecting your credit rating. You can also under another section of the act negotiate the terms of your contract.
If you have financed your car and are finding the repayments unaffordable, you can do something similar where you speak to the lender and either negotiate securing the car loan against the car to bring the repayments down if it’s not already a secured loan or you can agree to sell the car yourself and negotiate a settle for less payment of the shortfall if any or unsecuring the shortfall from the car itself and repaying this over time.
Remember the aim is to reduce your expenses, increase your earnings, eliminate debt and most importantly create wealth, so you can be in a position to live life on your terms and not have to settle for less.. that’s what your financier should be doing, not you.