Consumer debt is killing your wealth and any chance you have at making it to Financial Independence. Many people describe it as a feeling of drowning. Yet despite telling you this repeatedly you keep ignoring me. I’ve come to realize that I usually ignore what I don’t understand. So, let’s get to understand what the hell we are talking about before we discuss the perils of consumer debt.
Investopedia defines consumer debt as “debts that are owed as a result of purchasing goods that are consumable and/or do not appreciate. Consumer debt is often used alongside household debt as both are often connected with credit cards, mortgages, auto loans, and payday loans. It should be noted, however, that home mortgages are personal investments.”
Complicated? Well, it’s not. It’s just making a distinction between good and bad debt. For all intents and purposes lets just take the first part of the definition:” debts that are owed as a result of purchasing goods that are consumable and/or do not appreciate”. Ties in nicely to our definition of assets and liabilities doesn’t it. So, to simplify it further. Consumer debt could be classified as any debt you take to fund your liabilities.
So what are these liabilities that you would fund? Cell phone, TV, gaming laptop, Car, Bike, Washing machine, Iron Box, ironing board, Air conditioner, fan. The possibilities are endless, and none of these products will ever appreciate. ( unless you hold onto them for 20 years and some weird guy like me is interested in them as antiques.
Coming to types of financing you can use to fund these purchases.
- Credit Card
- Bajaj Finance
- Debit Card EMI
- Personal Loan
So why is consumer debt bad?
Let’s take a real-life case study. Let’s say I’m looking to buy a new cell phone. I am a big fan of the moto g series and so I look for the latest in the series. So, I head over to amazon and check out the new Motorola one. MRP:14999 Price to me 10,399. An additional 5% cashback on using HDFC bank debit cards. So, another 519.95 INR off. Making the price of the phone to me INR 9,879. Pretty sweet deal if you ask me.
Now let’s check out the other option of financing it. So, the best offer is on an amazon pay ICICI bank card. Which offers an alleged 0% EMI. For the 3 months plan, You pay INR 3,466 and for a 6-month plan you pay INR 1733 per month. SO, for both plans you pay 10,398 INR. Seems like a good deal. But is it?
1. Interest payment to your card provider continues happening
They basically take the cash discount they would have given you and give it to the credit card company in lieu of interest. Not really 0% interest is that? It’s definitely not in your best interest
2. You get charged additional GST on the interest that you pay
Yes, the GST paid will not be very large. But it all adds up to your amount due or outstanding. So, if you default they can charge you fees on a higher base. Plus, this is just a small purchase. I know of people who have 5-6 different EMIs for consumer products. For each of their interest payments, the government is taking a cut in the form of GST. Hey, id just rather keep all that interest and GST component in some asset churning out more money for me.
3. If you default on your payments the charges are ridiculous
Yup think about it. The Credit card company will receive the interest on the loan regardless. But if you should default on the payments, hell hath no fury. I mean it! the charges late fees and other components will make your eyes bleed.
4. You’re paying an effective 20% interest per annum on the 3-month plan and 10% interest per annum on the 6 month plan
How did I arrive at this figure? Well by buying with your credit card you’re effectively letting go of the 520 INR discount you could get. So, if you fiancé it for three months that’s a 5% additional payment you need to make for borrowing the money for 3 months. Multiply by 4 to round it off to a year and you have an annualise IRR of 20%. Similarly, for the 6month plan you multiply by 2 to make it a year and you have an IRR (Internal Rate of Return) of 10%. I dare you to find any other investment of yours that can generate that kind of returns. Put in other words its better to pay the money upfront and take the discount as compared to keeping the same in an FD for the same period.
So, what can you do?
1. Always buy with Cash
What I mean is always buy with cash sitting in your account. Buy it using your credit card if your getting a better deal. But at the end of the month pay your card payment in full. If there’s just one takeaway you need from this article this is it. If you follow this rule you’ll almost always get a better deal. If you can’t buy it with cash and have to finance a consumer product you cant afford it. Simple as that. Go get your savings rate up so you can afford it
2. Run the numbers
You weren’t happy with the simple solution were you. Well then run the numbers on all the options that are available out there. This might be time consuming and you need to know the workings of financing. Its worth spending the time to understand the market. But usually when our monkey brain is in the mood to buy something new it won’t be able to run numbers.
3. Consider a “pre-owned “option?
What?? Pre-Owned? What do you take me for? There are tons of people who love to blow their money on having the latest gadgets. Before the year is out, they might choose to upgrade. And sell their latest on the market gadget at a very juicy discount (depreciation). Phones, for example, depreciate like crazy. So do laptops and other consumer durables. More often than not you’ll find them online being sold at a discount of close to 50% of the launch price within 6-8months. Buy them then. Save 50% and the device is a lot more affordable. Or if that’s not up your alley. Amazon now has a renewed option. These are devices that are either shipped to someone and returned. Or previously used and refurbished back to good working order. Backed by a warranty from the seller. That being said I’m skittish about buying used consumer electronics in India. Unless you’re buying from a friend who you know takes good care of their stuff. Oh and this tip applies to large consumer goods such as cars as well. A used car can be a lot better value for money after someone else has taken a depreciation hit.
4. Never pay retail
Through the year you’ll find an endless number of sales. If you can put off your purchase and buy it when the sale is happening that’s cash saved. I picked up a fantastic pair of leather shoes from Clarks at 50% off. Affordable and quality. If you think ahead on what you need to buy you can hold plan things better including saving the cash, you need to buy it.
5. Never miss a credit card payment
I can’t stress this enough. In fact, just thinking about this stresses me out. I repeat do no miss a credit card payment. You’ll get chewed by the credit card company with late fess and payments and charges. To top it all you’ll do irreparable damage to your credit score. If you’re not sure that you have the full amount in the bank to buy the product your looking for. Don’t buy it on credit. Its not worth the risk of a delayed payment.
There are all kinds of deals to be had out there. The customer is king after all. If you have the cash everyone will chase you for it. It’s your responsibility to ensure that it isn’t wasted in filling others pockets unnecessarily. Do your future self a favor. Don’t burden him with having to repay debts that you took to improve your today. Instead, try and help him out. Save today so that your future self can afford a better tomorrow.
Till then may the Poixe(money) stay with you.