Credit cards vs. Debit Cards

[disneysteve]

If you had a disability policy in place, the payments would kick in to cover your bills - and no financial damage done.

That's not entirely true. Most disability policies have a waiting period. Mine have either a 60 or 90 day wait and you don't actually get the check on day 61 or 91. That's just when they begin the payment process. So realistically, I wouldn't see a penny from disability for nearly 3 months. But that's part of what my EF is for.

[littleroc02us]

Your example says nothing about the 'risk' of debt, and only says about the risk of not paying your bills on time. Which has nothing to do with debt.

Here's an example:

Say you had two responsible users,both married and have jobs where they make family combined incomes of 60k and both bought a $200,000 house with a 30 year @ 5.00% interest rate in 2006 at the top of the market, one paid cash for their house and the other decided to pay their mortgage monthly and invest the rest. Both users bring home 3600k a month and have no other debt. The mortgage borrower put 20% down to avoid pmi which was 40k. So his 30 year is based off of 160k with taxes his monthly payment would be $1067.25 a month. Other expenses during the month including insurance, food, gas, and entertainment add up to 1500k.
At the end of each month:

cash buyer would have: $3600-1500-200(taxes)=$1900 disposable cash.

Mortgage buyer would have: $3600-$2567.25=$1032.75 disposable cash.

Two years go by and the housing market is tanking and housing values have dropped 25% (That’s what my house dropped during the housing crash), the stock market has lost 35% (Vanguard Statistics on a 2 year period with an index fund that has done well since inception 8.5%) and both persons have lost their jobs. Where would these guys be at within 24 months from when they purchased their homes and how long could they last without jobs.

Cash buyer:
Would have saved: $44,600 and the house would be worth $150,000.
Roth IRA’s=$20,000 for 2 years (Lost $7,000 due to market crash, leaving $13,000)
Savings: $44,600 - $20,000 (Roth IRA’s)= $24,600 in savings/EF fund.

Net worth = $13,000 (Roth IRA) + $150,000 (House value) + $24,600 (EF fund) = $187,600

Mortgage buyer:

Would have saved: $24,768 and the house is now worth $150,000 due to the market, but the owner still owes $155,158.06 and is under water. He has paid $15,772.01 in interest and receives $3,930.50 back from the IRS.
Roths IRA’s=$20,000 for 2 years (Lost $7,000 due to market crash, leaving $13,000)
House: Underwater by $5,158.06 due to bust in the housing market
160k (cash) + $3,930.50 (Irs rebate) + $24,768 (savings) – $24,600 (savings/EF fund same as above) =$164098.50 total to invest
Other Investments=$164,098.50 (Lost $57,434.48 due to market crash, leaving $106,664.02)

Networth = $13,000(Roth IRA’s) + $106,664.02 - $5,158.06 (underwater house) = $114505.96

So how long does each individual last if he cannot find another job within 2 years off his net worth.
Remember monthly expenses for the cash buyer is $1,500 and $2,567.25 for the mortgage buyer.

1. The cash buyer can live off his EF fund for 16.4 months.
2. The mortgage buyer can live off his EF fund for 9.58 months.
• Both have the same EF fund of $24,600

So now the mortgage guy after 9 months has to start tapping in to his Roth’s IRA principles which was $20,000. He can take that out tax free and it will allow him to last another 7.79 months. So now he’s at 17 months and still has 7 months to go to make 2 years. What does he tap next? Now he has to start selling his other investments which will be taxed at 15% on pulling out your investments. He will need to pull out $20,666.36 to cover 7 months living expenses and 15% longterm tax.
The cash buyer will need to tap his Roth IRA’s for 7 months which would be around $10,500 tax free because it’s just principle.

At the 2 year mark the networth of both individuals would be the following:

Cash buyer: $152,500 networth

Mortgage buyer: $49,239.60 networth (plus the owner still has an underwater house.)

[jpg7n16]

That's not entirely true. Most disability policies have a waiting period. Mine have either a 60 or 90 day wait and you don't actually get the check on day 61 or 91. That's just when they begin the payment process. So realistically, I wouldn't see a penny from disability for nearly 3 months. But that's part of what my EF is for.

For long term disability yes, but for short term - like a sudden illness, it's usually less than that.

And yes, you should have a 3-6 month EF in place , and this risk would be managed.

From: Disability Income Protection Advice from MetLife

Short-Term Disability
Short-term disability benefits are often included as part of an employee benefits package. Short-term disability plans replace income for the early period of a disability. In general, the plans provide benefits that range from as little as two weeks up to two years. Plans often have a waiting period, sometimes called an elimination period. The waiting period is the period of time, after you become disabled until your benefits begin.

Short-term disability waiting periods are usually 0 to 14 days. For example, if you have short-term disability coverage with a 14-day waiting period, and a disability keeps you from working for three weeks, you will receive benefits for the third week of your disability, but not for weeks one and two. Those two weeks are the waiting period, during which benefits are not paid.

Long-Term Disability Insurance
As with short-term disability plans, your employer may provide long-term disability coverage. Benefits help replace income for an extended period, often five years or until the disabled person turns 65. Plans with longer benefit periods are more expensive. These plans can have different waiting periods, typically 60, 90, 180, or 365 days.

[littleroc02us]

Okay let me give you an example so you can see why:

H
Therefore paying with cash is risky. RISK!!!

Isn't that what you're trying to say?

No, because


Debt doesn't equal risk. Debt is just debt. There is risk in paying with debt, there is risk in not paying with debt - therefore, debt isn't the source of the risk.

Thanks for avoiding my Dave Ramsey question by the way - if you were able to answer it, you'd see why debt doesn't equal risk.

My wife and I went to Becker liquidation sale and bought furniture, we dealt strictly in cash and walked away. There wasn't a check it was cash, you know cash. How do I get a late payment on cash?

As for David Ramsey, yes he does tell you to stop saving if you lose a job and stock up with cash. He even tells you to stop paying your credit cards until you stock up cash to settle at a later time. This is what I have responded to posts with in the past.

[littleroc02us]

How is the person in your example a "responsible" credit card user if he/she forgets to pay the bill? A responsible card user would set up automatic payments before leaving on vacation and would probably double check online just to make sure the payment went through.

I'll agree with you though...it's risky to use a credit card if you forget to pay bills on time and live paycheck to paycheck. If that's you, stick with cash.

So no one in their entire life has ever made a mistake and forgotten to pay a bill or came up short that month?

[littleroc02us]

I've been away from the boards lately but my, what a fine discussion this has become.

littleroc02us, needless to say I firmly disagree with you. In your multiple examples, you are creating risk where it doesn't really exist. By my definition of "financially responsible", a person would have an EF, spend within their means and pay their bills on time. Somebody who doesn't do these things isn't responsible and shouldn't be using a credit card at all. I'd agree completely on that point.

Dave Ramsey, who I am a fan of as I've said before, deals primarily with irresponsible people. Because of that, he needs to tailor his advice to the irresponsible. He doesn't talk about how responsible people behave and handle money. That doesn't apply to the vast majority of his readers and listeners.

While we don't need a kitchen table, we did just purchase a new freezer last week so let's use that example. The process went like this. Over a 2-day period, we visited 6 or 7 appliance stores to shop around and find the best price for a freezer that met our needs. Then we went back to the store with the best deal, bought the freezer and paid for it with our rewards credit card. Including tax and delivery, it came to about $480. I could have paid cash but saw no reason to forgo the rewards. The price of the freezer wasn't going to change. We were going to spend the exact same amount no matter how we paid. So passing up the rewards simply made no sense.

Fortunately, neither of us have lost our jobs since making that purchase last week but what if we had? Well, the money for that freezer is already in our possession. Unlike the irresponsible, we don't use the card to buy things that we can't afford or don't yet have the money for. So even with a job loss, we still would have had absolutely no problem paying the bill. In fact, I could have come home and gone online that very day and paid the bill if I wanted to.

What about death or disability? Maybe I got in an accident on the way home from the store. If I was injured and couldn't work, our EF is more than adequate to pay all of our regular expenses and the cost of this freezer. Plus I have disability insurance. If I died, that EF would still be there as would the $1.5 million in life insurance that my wife would receive. I don't think the $480 freezer bill would be an issue.

I can't come up with any possible scenario where we'd be unable to pay that credit card bill in full and on time.

Let me tell you a quick story that illustrates the difference between a responsible individual like myself and most of the folks who call into Dave's show. In February 2000, I was fed up with my job. My wife and I discussed it and agreed that I should quit, so I did. I had no work lined up and had no idea what the future held but I wasn't staying at that job another day.

I ended up being out of work for about 2-1/2 months. I wasn't stressed. I honestly didn't even make a whole lot of effort to find another job. I was enjoying the down time. In fact, I came downstairs one Tuesday morning soon after leaving the job and asked DW if she'd like to go to Disney World. She said, "Sure. When?" I said, "How about Saturday?" Sure enough, 4 days later we left for a 10-day trip to Disney World. A couple of weeks after we returned from that trip, we went to Las Vegas for a week for a professional conference that I had scheduled prior to leaving my job.

We continued to use our credit cards regularly throughout the period of unemployment. And we continued to pay the bills in full and on time throughout the period of unemployment. How? With our emergency fund and savings. A 2-1/2 month job loss didn't even make a dent in our ability to maintain our lifestyle and enjoy ourselves.

Certainly, I realize that many people aren't so fortunate. But for those of us who are, using a credit card simply doesn't create any risk that isn't already there.

The point I was trying to make with my example that no one is getting is that no one person is perfect, no matter how responsible they are with money, mistakes are made and can cause a problem by borrowing someone elses money. If you paid for cash on something the deal is done and you move on, there are no interest rates, papers to sign, bills to pay, your done. It seems to me that no one on this forum has ever messed up in finances and had to pay stupid tax on a mistake they made. If none of you ever have, well then your perfect.

[littleroc02us]

DC are way more riskier. A lot of people just swipe their cards and don't track their spending and then they overdraft. It's way MORE likely when it's a couple and both of them are spending on the same account. Overdraft galore. Super easy to do.

That is true, but if you use and envelope system you can only spend what's in it and it's straight cash homey. (like Randy Moss says) There is no chance of overdrafting if you simply tie your savings account to your checking account for that purpose like my credit union does.

[jpg7n16]

Here's an example:

Say you had two responsible users,both married and have jobs where they make family combined incomes of 60k and both bought a $200,000 house with a 30 year @ 5.00% interest rate in 2006

1) This post of your's is waaaaaay off topic for the thread we're in, as we're discussing CCs - not mortgages

2) You forget that the mortgage buyer can sell his investments, to prolong his family's ability to cover expenses while out of work. Add another 41.55 months to the mortgage buyers timeframe, which discounts any recovery in investments and real estate over that time frame (which we know markets have rebounded, extending the time he could be out of work)

So the cash buyer would be forced to sell his home after 16.5 months (cannot borrow against home as he has no income), and the mortgage buyer would have 50 months. How is that riskier?

3) The effect of mortgage vs investing has already been covered in this thread here: http://www.savingadvice.com/forums/p...down-plan.html

4) In your example, the adverse affects to the mortgage buyer were due to real estate risk and market risk - not debt risk. Had he invested his additional $160k cash in a money market account, he would still be much better off than the cash buyer. Ergo - the consequences were not due to his mortgage (aka debt), but due to his investment choices. (a $200k investment in real estate and a $160k investment in the stock market)

[jpg7n16]

My wife and I went to Becker liquidation sale and bought furniture, we dealt strictly in cash and walked away. There wasn't a check it was cash, you know cash. How do I get a late payment on cash?

Checks are cash equivalents. Debit cards automatically reduce bank balances.

Physical cash can be stolen from you in the parking lot outside Becker - with no recourse. If someone steals your credit card, you can call and cancel it - and be reimbursed for any fraudulent charges. People could give you counterfeit bills that turn out to be worthless. etc.

Seems like carrying cash is risky.

As for David Ramsey, yes he does tell you to stop saving if you lose a job and stock up with cash. He even tells you to stop paying your credit cards until you stock up cash to settle at a later time. This is what I have responded to posts with in the past.

I know he does. But if the debt was the risk in losing your job, why doesn't he keep trying to eliminate the debt??

Could it be because the real risk in losing your job is not having debt, but running out of cash for food?

[littleroc02us]

1) This post of your's is waaaaaay off topic for the thread we're in, as we're discussing CCs - not mortgages

You asked me for an example of risk.

2) You forget that the mortgage buyer can sell his investments, to prolong his family's ability to cover expenses while out of work. Add another 41.55 months to the mortgage buyers timeframe, which discounts any recovery in investments and real estate over that time frame (which we know markets have rebounded, extending the time he could be out of work)

Are you sure you read the post, I showed how much he would have to take out of his EF, Roth and investments, it's all there and the math. I was using a 2 year time limit, because it shows the huge hit a mortgage borrower takes vs. the cash guy. And the point is in how much money the mortgage buyer would have lost vs. the cash buyer and the sustainability, plus the cash buyer could sell his house for 150k and have that to live off of, whereas the mortgage guy only had 49k left and that's it. Do realize that is all he'd have because his mortgage is under water. So I'm not sure where your getting these numbers, but their incorrect. Show me correction in my math then.


So the cash buyer would be forced to sell his home after 16.5 months (cannot borrow against home as he has no income), and the mortgage buyer would have 50 months. How is that riskier?

Wrong, I did the math above. In the 2 years that I laid out in the post, he would only have to touch his EF and 10.5k of his Roth IRA principle. Ahhhh, he could sell it for 150k.... Which would give the cash buyer another 100 months, I think he could live off that. If the mortgage buyer sold all of his remaining investments and have nothing left it would only last him around another 16 months at most because of taxes which only is around 40 months total vs. 100 months for the cash buyer.
3

4) In your example, the adverse affects to the mortgage buyer were due to real estate risk and market risk - not debt risk. Had he invested his additional $160k cash in a money market account, he would still be much better off than the cash buyer. Ergo - the consequences were not due to his mortgage (aka debt), but due to his investment choices. (a $200k investment in real estate and a $160k investment in the stock market)

So you as an investor would have kept the money in a money market instead of the possibility of getting better returns in the stock market. Is that really how you invest? I made the comparison apples to apples except how they paid for the mortgage.

[GREENBACK]

I don't think the emphasis on rewards cards has been stated enough. We responsible CC users understand the potential risks involved with using these financial tools but I, like many here, reap substancial rewards for using our CC's and not carrying a balance. There is risk in everything you do financially. Just cause you use cash doesn't mean you assume no risk. If you buy a T.V or a kitchen appliance with cash but can't swing that electric bill at the end of the month, I'd say you made a risky choice. How's that different from the CC user?

Banks realize that there are irresponsible people who can't properly handle a CC account. That's the game they play but I don't see any inherent risk with using a CC card. Again I'll state that the method of payment doesn't automatically create a risk.

[disneysteve]

Here's an example:

Say you had two responsible users,both married and have jobs where they make family combined incomes of 60k and both bought a $200,000 house

This has nothing to do with credit cards but I'd stop right there. A couple earning 60K shouldn't have spent 200K on a house. That was not a responsible purchase.

So no one in their entire life has ever made a mistake and forgotten to pay a bill or came up short that month?

Two very different issues there. Yes, I have accidentally missed a payment in the past, though I haven't done it for many years. I called and had the late fee waived without a problem. I'm not denying stuff can happen, so if that's what you are calling risk, I'll go along with that one.

As for coming up short, absolutely not. How can you possibly come up short if you are only using the credit card to make purchases for which you are already holding the cash to pay the bill? Yes, if you go insane and decide to spend the cash before the bill comes, that would be a problem. But we're talking about responsible people here. Responsible people don't do things like that.

If you paid for cash on something the deal is done and you move on, there are no interest rates, papers to sign, bills to pay, your done.

Despite that, millions of people pay millions of dollars every year in overdraft fees by spending more money than they have in their accounts and bouncing checks. Avoiding credit cards does not somehow make you more responsible with your money. If you are going to screw up, you are going to screw up. The credit card isn't the problem.

[jpg7n16]

Are you sure you read the post, I showed how much he would have to take out of his EF, Roth and investments, it's all there and the math. I was using a 2 year time limit, because it shows the huge hit a mortgage borrower takes vs. the cash guy. And the point is in how much money the mortgage buyer would have lost vs. the cash buyer and the sustainability, plus the cash buyer could sell his house for 150k and have that to live off of, whereas the mortgage guy only had 49k left and that's it. Do realize that is all he'd have because his mortgage is under water. So I'm not sure where your getting these numbers, but their incorrect. Show me correction in my math then.

No you didn't use a 2 year time limit to show the hit, you used it to make a scenario end in 2008, where the numbers would look the worst for a mortgage investor. If you began your little 2 year scenario in 2008, it'd show a completely different result. This is evidence of the market risk I wrote about in my last post. This has nothing to do with 'debt risk', and everything to do with market risk.


As is very apparent, I never trust your math. There's always some kink in the works where you conveniently forget something that lets your preferred method have some crazy advantage.

I used your own numbers.

24,600EF / 2567.25 monthly exp = 9.58 months expense
+ 106,664.02 liquid investments / 2567.25 monthly exp = 41.55 months expenses <---- this is the part you forgot to consider
Grand totals: 131,264 available to live off for 51.13 months, before being forced to sell the home

Ta da! Mortgage holder is in a much better position to weather the spell of unemployement, without upsetting his life.


The risk isn't just in losing money - it's also in forcing your family to sell their home and move, at a time when the real estate market is at a low. The mortgage investor has the liquidity to wait it out, and let home and market prices rebound.

You seem to ignore liquidity risk. The cash purchaser has little liquid assets that are quickly exhausted, the mortgage holder has ample liquid assets.


And you went back and edited to show how when he sells the home at $150k, he'll have 100 months to live off of right? There's always something you forget. They don't get to live rent/mortgage free after they sell their home.

I will never trust your math.

So you as an investor would have kept the money in a money market instead of the possibility of getting better returns in the stock market. Is that really how you invest? I made the comparison apples to apples except how they paid for the mortgage.

It doesn't matter how I'd invest- and that's not the point. You are mis-identifying where the real risk came from.

An investor could have invested in a money market fund and not been at risk of losing 35% from 2006 to 2008, because MM accounts are not subject to market risk.

The risk didn't come from the debt - it came from the investment choices.



Sooooo getting back to the actual topic...

You can use CC's responsibly and not incur any additional risk.

[LivingAlmostLarge]

Littleroc your math on the mortgages is off. In a bad market, the cash person would run out of cash faster and need to sell their home which dropped. Stock market dropped 35%. But you would need money for taxes, insurance, etc on a home anyway. No job = no line of credit.

Now then the mortgage person could sell their loser stocks and keep up with their lifestyle. Assuming a 50 month window and there isn't a recovery sooner, then they'd be set. The cash person would need a job because to sell a home at $150k will still cost $15k out of pocket.

Don't they have to pay commission? So that would cut into their savings. Then they'd still have to rent a place, but now they would walk away with $135k + investments. And they would put the house up asap, because I know and you know in a bad housing market it won't sell within 6 months. So they had better hurry.

Also you only pay 15% tax on earnings so the stocks lost 35%. So it'd an actual tax break on the sale of these investments. The purpose of the cash for the paid for home IS to pay the mortgage if you lose your job.

Bottom line...I think you are completely missing the point about why someone who had the common sense to save $200k, wouldn't cash it in and be surviving in their house longer than the cash buyer who NEEDS to sell their house in order to survive.

Second, you never responded to how my mom uses a CC for TONS of airmiles and yet her overanal self just always pays it off asap. So how can she ever get into trouble? She basically treats it like a checking account, constantly paying it off. The bill comes and it's $0. But she earns every rewards and has never had a late fee or interest (neither have I in 20 years).

So where is the risk for her? She has a checking account register and knows to the penny she can spend X amount. But she isn't about to pass up free miles.

[littleroc02us]

[QUOTE=disneysteve;289219]This has nothing to do with credit cards but I'd stop right there. A couple earning 60K shouldn't have spent 200K on a house. That was not a responsible purchase.

Why, it's only 30% of their income?????