Sometime when you’re using a credit card this holiday shopping season, stop and think for a minute what that rectangular piece of plastic actually represents.
On the plus side, it’s a useful money management tool that often beats cash by a mile when it comes to such important attributes as convenience, flexibility and security.
And if you play your card right, it can also cost you little or nothing to use. This advantage comes with paying off your balance due on the card promptly each month, and avoiding or at least minimizing interest charges.
Once you start carrying an unpaid balance from month to month, however, a credit card becomes something quite different - a costly way to borrow money.
It is that characteristic that explains why so many banks, retail establishments and other institutions are so eager to plant their cards in your wallet.
Les Nanberg, senior vice president at the investment management firm of Massachusetts Financial Services, observes that card issuers can still make a lot of money, even if something like 4 percent of the customers default on their debts.
Consider this simplified example:
You spend $600 at a retail store, charging your purchases on the store’s credit card. In January, when your statement arrives in the mail, you pay off only $100 on your account.
The other $500 becomes a loan, accruing interest at the annual rate set by the store of 19 percent. To finance the loan, the store borrows in the money markets at 5.5 percent.
Now suppose it can estimate pretty reliably that it will lose 4 percent of what it lends to customers who can’t or won’t pay. That still leaves it a “spread” of 9.5 percent - or 50 cents of each dollar of interest that accrues on its cards.
Out of that spread, the store can pay the costs of its computers, printing and mailing of cards and statements, salaries and benefits of its credit-department staff, and so forth - and still book a tidy profit.
And who is paying the bill for all this? Nobody but you, the credit-card borrower, out of your (most likely after-tax) take-home pay.
As long as you have this drain on your finances, carrying a card balance from month to month in the new year, the more likely it is that next Christmas you will once again shop on borrowed money, starting the whole cycle over again.
The way to break the cycle is, just once, to get your cash flow caught up with your spending, so that you can pay off your card balance. After that, you will still need to match your outgo to your income to stay out of debt, but you will no longer be starting out from behind each month.
Some tactics and tricks to avoid borrowing during the holidays what you can’t pay off soon afterward:
Agree in advance with friends or relatives to mutual gift-spending limits, or even to exchange gifts of no-cost services such as baby-sitting time.
Forbid yourself to impulse-shop for yourself while on holiday shopping expeditions.
Do all your shopping within at least an organized plan, to avoid spending too much for one of your loved ones at the outset and then feeling duty bound to overspend just as much for all the others on your list.
Keep records so that you don’t lose track of your credit card spending. New York’s Citibank, which says American consumers charged purchases at a rate of $4 billion a day in last year’s holiday season, is offering its customers a “credit minder” card holder that contains a spending log in the style of a checkbook record.
You can devise your own record-keeping system, maybe as simple as a folder in which to keep all your charge receipts.