Debt Archives - Financial Samurai

If The Economy Tanked, Would You Be Ready?

The following is a sponsored post by Credible, a multi-lender marketplace that enables borrowers to receive competitive loan offers from its vetted lenders. Credible is headquartered in my hometown of San Francisco, California.

The U.S. is in the midst of its longest economic expansion in history.

But when the Federal Reserve cuts interest rates, that’s usually a sign that the economy is slowing down — or worse. After raising rates nine times from 2015-18, this year the Fed has reversed course, cutting the short-term federal funds rate three times.

Another worrisome trend: New York Fed data shows the unemployment rate for recent college graduates (red line) has been inching upwards this year, suggesting employers are skittish about growth.

Unemployment rates for recent graduates, college graduates, and all workers

It’s impossible to predict when the next economic downturn will come. But the booms and busts of the business cycle are pretty much accepted as a necessary tradeoff of our free-market, capitalist system — which has weathered seven recessions since the 1970s. At the very least, it is clear that growth is slowing in both developed markets and emerging markets around the world.

In a recent CNBC/SurveyMonkey poll, nearly two-thirds of Americans said they think it’s likely we’re headed for a recession next year. Close to half of those who see storm clouds on the horizon are preparing for it by cutting back on household spending and paying down debt.

“This refreshing prudence on the part of the U.S. households is, of course, exactly opposite of what macroeconomists at the Fed — as well as incumbent politicians who view lower rates as enhancing their re-election prospects — want to happen,” says former FDIC Chairwoman Sheila Bair.

Rate cuts are designed to encourage people to borrow and spend. But this time, Bair says, “it looks like American households have learned their lesson, even if Washington has not.”

Whether or not a recession is coming next year or not, it’s always a good idea to constantly be managing any outstanding debt you’re carrying, whether its credit card balances, student loans, or a mortgage.

Make sure:

You’re not paying a higher interest rate than you can qualify for
Most of your monthly payment is going toward paying down principal, rather than interest charges
You’re prioritizing your loans with the highest interest rates
You have a good cash balance equal to at least six months of living expenses

Let’s look at some techniques you can use to whip your credit card, student loan, and mortgage debt into shape and get better prepared for the next recession.

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The Average Credit Score To Qualify For A Mortgage Is Now Very High

Posted by Financial Samurai 35 Comments

As mortgage rates tumble to multi-year lows, there’s been a massive surge in refinances and new mortgage applications. The drop in mortgage rates is one of the key reasons why I don’t think there will be a housing downturn as vicious as the one we saw between 2008 – 2010.

Further, it takes about six months for the effects of a large mortgage rate change to show up in the housing data. Pent-up demand is building as buyers take a wait-and-see approach to the economy.

If you want to get a better indication of what the future might look like, simply check out the performance of a homebuilding ETF like XHB. Homebuilders and home-related stocks performed tremendously in 2019.

In addition to lower interest rates, higher lending standards post-financial crisis is another reason why the next recession shouldn’t be as bad as the last.

Gone are the days of negative amortizing liar loans to people with terrible credit. It has become far more difficult to get a mortgage today. Let’s look at some data.

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Paying The Average Credit Card Interest Rate Will Keep You Poor Forever

Posted by Financial Samurai 29 Comments

The worst type of debt is consumer debt.

One reason why consumer debt is so bad is due to people buying things they really don’t need: a fifth pair of designer jeans, another luxury watch, every electronic gadget imaginable, and so forth.

But egregiously high credit card interest rates are the main reason why consumer debt is the worst type of debt for your finances. If you keep revolving credit card debt, you will likely stay poor forever.

Let’s take a look at the current average credit card interest rate.

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Child Millionaires: Not Necessary Thanks To Canceling All Student Debt

Posted by Financial Samurai 143 Comments

One of the things many responsible parents are doing today is saving for college. Not saving for college and expecting a student loan bailout in the future is bad planning. The same goes for not saving for retirement and hoping the government will take care of you once you can no longer work.

Do you really want to take that chance? I don’t think so.

Given college tuition is rising by roughly 6% annually a year, by the year 2033, the cost for one year’s worth of public or private school tuition may approach $54,070 and $121,078, respectively.

Add on expenses for room, board, travel and miscellaneous stuff and the annual cost of college could easily be 50% – 100% higher.

Meanwhile, according to the National Center for Education Statistics, just 41% of first-time full-time college students earn a bachelor’s degree in four years, and only 59% earn a bachelor’s in six years.

Therefore, it is only logical that all of todays’ new and future parents should try to save about $1 million for each child’s college education. If a family has a “trophy kid,” then the family should save $4 million and so forth if college is the desired path. Going into debt to buy a depreciating asset like a car or a college degree is fiscally unsound.

No parent should expect their child to be brilliant and get scholarships. Nor should any parent expect their child to be sensible and attend a public institution to save on costs. High expectations lead to disappointment.

No matter how many articles I write about the depreciation of a college degree, not enough people will listen because the desire for status is too strong. We also all believe that we are more talented and smarter than we really are.

Parents can hope for sensibility, but should still plan to spend the big bucks.

However, to save for our children’s college education often means that we are unable to save as much for our own retirements. This, in turn, may cause financial anxiety and unhappiness within the household.

Perhaps the Cancel Student Debt movement is a solution. Probably not.

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Steps To Get Out Of MASSIVE Credit Card Debt Due To Lifestyle Inflation

Posted by Financial Samurai 49 Comments

I don’t discuss too much about credit cards on Financial Samurai because I’ve only got two (a cash back rewards card, and a cash back business card) and nothing much happens except for racking up rewards points. Definitely use a credit card for convenience, safety, rewards points, and insurance protection if you can control yourself. But if you’re not careful, thanks to the ease of use and absurdly high interest rates, problems may ensue.

The following is a guest post by Financial Samurai reader, Debs, a middle income earning new grandmother who was able to amass over $140,000 in credit card debt! I asked her to share her story on how she did it, and how she is getting herself out of debt. Kudos to Debs for having the courage to share her story.

_{Disclosure: Financial Samurai has partnered with CardRatings for our coverage of credit card products. Financial Samurai and CardRatings may receive a commission from card issuers. Opinions, reviews, analyses & recommendations are the author’s alone, and have not been reviewed, endorsed or approved by any of these entities. Responses are not provided or commissioned by the bank advertiser. Responses have not been reviewed, approved or otherwise endorsed by the bank advertiser. It is not the bank advertiser’s responsibility to ensure all posts and/or questions are answered.}

It’s embarrassing to admit, but I tell this tale as a warning to all people like me who are on the bandwagon of lifestyle inflation, “I deserve” and family struggles that may cause you to take your eyes off the ball and wake up one day to say “How did I get here?”.

We weren’t addicted gamblers or smokers. We didn’t have a lot of fancy toys. We drank moderately and yes, we had four kids and a large home to boot (purchased in 1991). Maybe a few travels thrown in here and there, but not excessive. There was some shopping for work clothes and things for our home. Maybe a bit of stress relief shopping, but nothing extravagant. That is my first message.

Our debt crept up on us without even realizing it. At least I didn’t realize the size it had grown to. I wasn’t watching the finances. I was only working hard to contribute to the family income. That was enough, or so I thought.

Why We Got Into Big Debt

In retrospect, I can see how we made some mistakes that didn’t help us. We financed a swimming pool in 1995 because we wanted to have a backyard oasis while the kids were young enough to enjoy it. That (a) was not a smart idea and (b) increased our mortgage payments, which we thought we could afford. Apparently not, because our home equity line of credit (HELOC) started to grow after that.

We never budgeted, we didn’t track spending. We just figured that as long as we weren’t going overboard, things would look after themselves. If we didn’t have all the funds to pay our credit cards, the balance was paid with the HELOC. Then my husband lost his job. Income came down so we did a refinancing and rolled the LoC into the mortgage and off we went again, changing nothing about our spending habits, still not tracking, just living. Strike 1.

My husband went for training in a different career (real estate sales) but this was a lot of work compared to the return, especially at the beginning. A number of years went by, and we came back to the trough again. Strike 2. This was the “do or die” refinancing. We were never going to do this again. Yet, we did not change anything except to say we never wanted to be in that position. As if it would just magically occur because that’s what we wanted.

Again still no regular analysis or tracking of spending was performed, and certainly no targets set either. We were free falling. We didn’t take any second jobs or sideline work, the only thing we did do to bring in some extra income was rent out a room in our basement. After a few years, we had a freak storm and major flooding in our basement. This stopped the student renters for a period of time and once we had stopped we never got around to starting again. Generally, it felt like we were too stressed out from the day-to-day hustle to even realize what our problem was. Ignoring things, saying “I deserve”, people pleasing were all part of our psyche. I left all the family financing to my husband, and in retrospect that was a big mistake. It seems that he is “penny wise and pound foolish” but I am actually the frugal one in the family.

Repeating the same events is the definition of insanity, and I plead guilty.

Strike 3 gave me the shock of my life like I had the wind knocked out of me. It happened in March 2012 when I discovered that our family debt consisted of the following:

$26,000 of original mortgage debt including the refinancing for the swimming pool (not bad)
$71,700 of a second step mortgage (Strike 1) which probably started at around $100K in 2005
$100,000 in home equity Line of Credit
$100,000 in credit card debt that started from low interest rate balance transfers but eventually grew, especially when the interest rates increased to normal prevailing credit card rates
$47,500 of normal credit card charges
$27,700 remaining on a truck loan
$20,000 remaining on a car loan

The grand total was $393,500. I was 52 years old and my husband was 59. It was a personal debt disaster story.

The First Steps To Solving Our Debt Problem

It was the shock I needed to take action and take things into my own hands. I considered divorce. I didn’t consider bankruptcy. I don’t know if that could have been a prudent option for us or not. It wasn’t a word in my vocabulary, given I was earning six figures. But first, I had to stem the bleeding, so we initially took the following steps.

Arrange alternative financing at lower interest rates

We marched into our bank to figure out the options. I needed to get that debt off the credit cards A.S.A.P. to avoid the continued high interest rates. We took out a $235,600 mortgage with the equity in our home at 2.79% for 3 years, which would wipe out our HELOC and the large credit card and most of the other credit card. The bank could not advance us enough equity to wipe out all existing lines of credit, so we were left with a LoC for $11,900 at 7.9%, which was too high a rate for my liking.

Create a detailed budget and track spending

I created a budget and tracked every penny of spending in an excel file. Eventually I moved to doing this in Personal Capital as well, but did not abandon my excel file. I need my excel for cash flow forecasting and it gives me a second check on what is going on. Before our debt crisis day, I used the excuse that I did not have the time to do this. Now that we know how important it is, I do not mind doing it twice. ;-)

Renegotiate service plans

We renegotiated phone, TV and internet plans. It is amazing how willing the providers are to reduce your rates when you tell them you are considering moving to the competition because the costs are too high. We reduced our cable by $80 / month initially. We have since reduced costs further in these areas (see below).

Conduct a detailed analysis

With some initial steps taken to reduce costs, I was still recovering from shock and trying to figure out if we could repair our marriage and rebuild trust. I needed to go back into history to figure out how the two credit card debts of $100K and $47K came about. How these amounts grew so large seemed unfathomable to me, since it certainly didn’t seem like we were living beyond our means. What I was able to piece together was that it these amounts grew just on a few hundred here or thousand there that could not be paid off based on monthly cash inflows.

Why wasn’t our cash inflow enough even with a six figure income? We were servicing a HELOC of $100K for most of those years, so were paying $6K – $8K of interest charges annually. Since this money was going to interest, there was no extra cash flow for home maintenance and other incidentals. Enter the cycle of robbing Peter to pay Paul. When I went back to re-tabulate, I arrived close to $100K in interest charges over about 18 years. Most of it was from the $100K HELOC , but towards the end, credit card interest started compounding as well. After that, I stopped following the money trail. I was sick of looking back and as bad as I felt, it wasn’t enough to throw away 22 years of marriage, so it seemed.

So I am here to say, this is how easily it can happen if you do not manage your money. Our combined income has ranged from $100K – $150K annually during this period of debt accumulation. At the start of our debt recovery in March 2012, our financial net worth excluding the value of our home was less than $100K. Our home is valued at about $500K.

How Did We Reduce Our Debt?

I can attribute this to tracking our spending against a budget and living reasonably frugally. In addition, we have deployed the following strategies to help reduce interest costs, reduce expenses , increase income or help with cash flow management.

We increased our amortization periods on our older two mortgages, to allow for some breathing room on cash flow. We didn’t pay less overall on our debt, we just paid higher interest debt first. We have deployed all available debt prepayment options on our mortgages with available cash including:
1. annual prepayments (which don’t have to be done all at once with our bank, but can be done in pieces anytime up to a maximum annual amount per mortgage year)
2. payment increases by 15% once per year (which means original mortgages that were lowered are now being increased again as we wipe out other debt and have increased available cash flow)
3. match a payment (doubling of our payment which means the second payment goes entirely to principal and we can stop any time.) This feature, available at our bank, also acts as a type of insurance for lost income since we can miss payments in future if needed in the event of a job loss, and not be considered in default of our mortgage.
I have transferred vehicle debt or mortgage debt to a low rate credit card twice since beginning our debt repayment journey. Once to pay off our truck which was at 5.1% and once to make a large prepayment on our mortgage. I may continue to deploy this strategy, but only under the following conditions, because you need to take care of the low rate cash advance credit card pitfalls:
1. when I’m sure I can pay off the balance in the time required before the interest rate hike. (Last one was an eleven month period at the low rate).
2. I don’t pay a transfer fee and only consider 0.99% interest rate. The transfer eats up too much of the interest savings to make this worthwhile, even if only 1%. Since I pay off the balance over time, I see the interest costs decline over the term.
3. I will not do this any time near a mortgage renewal date, which would require a credit check. Our credit utilization rate would be raised after doing the balance transfer and this could inhibit our ability to get the lowest possible interest rate for the mortgage renewal.
We use cash back rewards credit cards that pay 4% on gas and groceries. Our credit cards are paid off monthly by the due date. There is no carrying of credit card balance except in item 2 above.
We rent a room in our house for $460 / month.
We switched to a more reliable and cheaper internet provider and have replaced our home phone with a internet based system – savings $50 / month.
We have just recently cut cable and will save $83 / month.
We negotiated a better cell phone plan, saving at least $27 / month.
We limit our entertainment spending and travel, but have managed to take one trip using accumulated business travel points and some planned savings to attend a family wedding.
We’re currently focusing on ways to reduce our grocery/miscellaneous budget, which may involve simple tactics like keeping my husband out of the store and other fun games. :-)

The longer we live like this, the more we see opportunities to reduce our spending even further. It’s definitely a journey, putting one foot in front of the other on our march towards debt freedom. This year we have paid on average 61% of our net income.

Today we have paid off almost $147K in 2 ¼ years. We still have 4 years to go to reach debt freedom.

Many people with lower incomes may scoff at our ability to pay off $65K annually but I want to stress that it is all relative considering the size of our debt. Sure, I earn a good salary, but it is 64% of the $200K, Financial Samurai deems the right amount to be ‘happy’. In addition, my husband earns only 60% of the average Canadian wage of $48,250. Thankfully, his income is supplemented a little with a $321/month survivor benefits from his first wife who passed away.

Now, after more than two years of debt payment and good retirement portfolio equity market returns, 50% of our net worth is from our home, which we will renovate and sell after we are debt free. Some may say, why not sell now and wipe out the debt instantaneously and start fresh? It has been considered and is still a point of discussion from time to time. We delay because we would need to do substantial kitchen and bathroom renovations in order to get the best return for our home which is in a good location. We do not want to increase our debt load in order to make that happen.

I’m not going to say it’s easy with a long term debt cloud hanging over your head, but I am going to say it’s possible. We are taking twice as long than what is normally recommended as the maximum to get out from under it – six years versus three.

I hope that when we are done, we do not have any regrets about not downsizing our home during this period. I also think that the habits and skills we are developing now will serve us well in retirement, continuing to live frugally, and appreciating what we have and how far we’ve come.

The Best Cash Back Credit Cards

If you’re mature enough to utilize credit cards for your benefit by paying off the balance in full each month, then credit cards are a wonderful financial tool to improve your life. Not only do you get an interest free loan for a month, you get buyer’s protection, and rewards points. I think everybody should have at least one cash back rewards credit card. Here are the three best that I’ve found:

Capital One® Quicksilver® Cash Rewards Credit Card

Simple and straightforward, the Capital One Quicksilver offers flat rate cash back rewards. Cardholders earn 1.5% cash back on all purchases without any spending caps.

Key Benefits

1.5% cash back on every purchase
Rewards are unlimited, ie no spending caps
Zero foreign transaction fees
No annual fee
Get a $150 cash bonus reward if you spend $500 in the first 3 months

Read more and learn how to apply

CapitalOne Quicksilver Cash Rewards Credit Card

Chase Freedom Unlimited

If you’re looking for a flexible cash back rewards credit card that isn’t complex, this is it. The Chase Freedom Unlimited credit card offers great flat rate rewards.

Key Benefits

Earn a $150 bonus after spending $500 in the first 3 months after you open an account
Get unlimited 1.5% cash back on all purchases you make
Introductory 0% APR for first 15 months on purchases and balance transfers (3% balance transfer fee applies)
No annual fee
Redeem cash back with no minimums

Read more and learn how to apply

Capital One® Savor® Cash Rewards Credit Card

This is a tiered cash back rewards credit card by Capital One that offers an impressive 4% on dining and entertainment without any spending caps.

Key Benefits

Unlimited 4% cash back on dining and entertainment
2% cash back on groceries with no spending caps
Unlimited 1% cash back on gas and all other purchases
Get a $300 cash rewards bonus if you spend $3,000 in the first 3 months
$0 waived annual fee for the first year

Read more and learn how to apply

CapitalOne Savor Cash Rewards Credit Card

I hope everybody has at least one cash back credit card in their wallet. Just make sure never to carry a revolving balance. Use credit cards to your advantage for the rewards points, insurance protection, and one-month interest-free balance. Never let credit cards take advantage of you.

About the author: debtdebs is a fifty-something wife, mother and new grandmother, who admits to having her “head in the sand” about their financial situation until amassing $247,500 of consumer debt for a total debt of $393,500. She shares her story with all those coping with poor money management decisions.

How Much Is The Average Credit Card Debt Per Household?

Posted by Financial Samurai 51 Comments

How many times have you withdrawn a wad of cash only to see it disappear a few days later with little idea where it all went? By putting as much expenditure on my credit cards as possible I get a handy dandy pie chart and expense line breakdown at the end of every month to see where my money is going. Furthermore, I get all those juicy rewards points that really begin to rack up over time.

Credit card debt is on the rise and the U.S. average household owes a crippling amount. Households in California owe the most with a whopping average of $10,175 in 2019 according to WalletHub with Texas and Florida coming in a close 2nd and 3rd.

According to CreditCards.com the average credit card debt per U.S. adult is $5,673. And the average debt per credit card that doesn’t usually carry a balance is $1,154 (must equal spend). They also report lower findings per state and list Alaska with the highest credit card debt at $7,726 followed by New Jersey at $6,881 and Connecticut at $6,876.

ValuePenguin lists the average credit card debt per household at $5,700 and at $9,333 for average balance-carrying households.

Average credit card debt per household

According to TransUnion, the average credit card balance per consumer was $5,554 in 1Q2019. Meanwhile, CNBC reports that only 10% of Americans have a monthly average credit card balance over $5,000.

Average monthly credit card balance

Depends How You Slice It

So you can see that it’s hard to figure out what’s the right number when it comes to the average credit card debt per household and per consumer. The figures vary a lot by source and by how the data is sliced and diced. One way to finding a better average credit card debt and spend number is to simply get more datapoints with a short four question survey below.

The impact on the amount of average revolving credit card debt per household is largely determined by income. You might have an astounding $15,000 in revolving credit card debt, but if you are making $1 million a year, who cares? The more pertinent measure is average revolving monthly credit card debt to average monthly gross income.

What’s confusing is that it’s unclear whether people who pay off their credit card bills every month are also included in the average credit card debt per household by each source. After all, when I charge something on my card, I have interest free debt for 28-31 days, depending on the month, until I pay the bill off in full.

The solution is to simply calculate the average credit card spend a month to the average monthly gross income, and calculate the average revolving credit card debt a month to the average monthly gross income to get a more thorough picture.

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How Many Credit Cards Should I Have Until It’s Too Many?

Posted by Financial Samurai 55 Comments

Various types of credit card logos, Visa, Mastercard, AMEX, Discover

Here are the best credit cards today if you are looking for an awesome rewards credit card.

I was having lunch with a buddy of mine when he whipped out his foot long man wallet to pay the bill. “Whoah!” I said. “Where do you keep that thing?”

“In my man bag, of course!” he replied with pride. Todd lifted up his soft leather Bally bag that probably cost a thousand dollars. “Have a touch,” he said as he tossed it over. Todd’s bag was as supple as a baby’s bum.

The reason why Todd’s wallet is so big is because he has 10 credit cards all nicely color coordinated from top to bottom. The most prestigious cards – the black ones of course – were at the top. But as I looked closer at his collection, every credit card of his said “Preferred,” “Platinum” or “Elite.”

Temptations

One could call Todd a credit card connoisseur. “I’ve got a card for every purpose,” told mentioned proudly. “Never leave home unprepared!”

Despite what is probably hundreds of thousands in credit at his disposal, Todd still rents a one bedroom apartment and has less than $80,000 his 401(k) at 35 years old because he’s spending all his money! In fact, he admitted to having around $18,000 in revolving credit card debt spread across seven cards. At least he’s got a nice BMW 650i coupe on lease for $899 a month.

So I got to thinking, maybe the reason why Todd has so little assets for a man making six figures a year is because of temptation from all his credit cards. When there are no cookies in front of me, I never eat desert. As soon as you put out a tray of gooey white chocolate chip cookies at my disposal, it’s game over!

The Most Credit Card I’ve Ever Had

Some people are completely against credit cards because they’ve gotten themselves into debt troubles before. Alcoholics should not hang around in bars. By only using a debit card or cash, such anti-credit card users help minimize themselves from relapsing into debt. I commend their cold turkey approach, but it’s not for me.

I recommend everyone have at least one credit card to build their credit score, use as an emergency, borrow money for free for 30 days, earn rewards points, and minimize the pain of losing cash when you lose your wallet. The question is, how many credit cards is ideal for optimal financial health. Let’s discuss!

The most credit cards I ever had was between the ages of 22-24 when I had five. I thought it was so smart to open up new credit cards with 12+ month long 0% introductory APR rates, pay the minimum for the full term and then transfer the balance to another 0% APR credit card. Borrowing money for free is always a splendid thing to do when you are young, poor, and have a lot of time on your hands.

Unfortunately, there’s a point where the “spend more, save more” mentality runs out. Notably when it becomes absolutely backwards to keep spending just because the interest rate is cheap. More than anything it felt annoying to always have a revolving balance so I decided to quit with my credit card shenanigans and just focus on better spending habits.

Down To Only Two Credit Cards

From 2001 to 2013 I only had two main credit cards: 1) my American Express corporate card and a 2) Citibank ThankYou credit card because I’ve been a long time banking client. The reason why I only had two credit cards was both physical and mental. On the physical front, I can’t stand having a thick wallet. The wallet is always in my right butt pocket for all you pickpockets out there and it’s uncomfortable to sit down when things are uneven. The second reason for having only two credit cards is due to record keeping.

By only having one personal card, I was able to comfortably keep track of all my expenses online and make sure I was not going over budget. For example, if I had a $2,000 a month credit card budget, I didn’t have to stay on top of numerous credit card balances. My expenses for the month were essentially my credit card bill + the amount of cash withdrawn from my checking account. Having one credit card made it much easier to SAVE money.

Now that I have a third credit card to earn points for travel, I’ve got to be a little more diligent about my spending. With a 0% introductory APR, 40,000 bonus points, and the first year’s fee waived, I’m reminded of the times when I had multiple credit cards once again. Now I’m tempted to take advantage of new credit card offers with bonus points. It feels a little like going into relapse!

Just imagine, if I can earn 40,000 rewards points just by signing up and use a credit card to buy a $100,000 Range Rover to earn a total of 240,000 points, why wouldn’t I? That’s five or six round-trip flights from San Francisco to Hawaii. Unfortunately, car dealerships usually only allow for a maximum of $3,000 to be charged due to fees they have to pay which cuts into their margins.

Average Credit Card Interest Rate By Card Type — Average credit card interest rate by card type 2017

The Biggest Risks To Having Multiple Credit Cards

I’m a big advocate of less is more when it comes to credit cards. Let me explain why I recommend keeping the number of credit cards you have to three or less.

1) More Credit Cards = More Temptation To Spend

If you have a budget of $1,000 a month to spend on your credit card(s), it’s much easier to limit spending on one card compared to limiting spending with five cards.

Your mind automatically starts thinking about the various custom rewards points for each card and you charge accordingly just a little more than you should. If you charge even $100 more on average between your five credit cards, you’ve gone 5% over budget for the month.

Compound the over budget amount over the year and just like that you’ve got $1,200 more in credit card expenses or debt that needs to be paid off. We can’t help but think of each credit card as one powerful spending tool with its own APR rate, fantastic benefits, and multi-thousand dollar credit limits.

Derivative Explanation: I threw a potluck at my house for 20 confirmed guests one year. One of my good friends said she’d make enough spaghetti for 20 people. I told her to just make full portions enough for five people. She looked at me stubbornly and said, “Well what about the other 15 guests?” I proceeded to explain to her that if all 20 guests made enough full-size portions for 20 people we’d have enough to feed 400 people! She didn’t get it and insisted to bring massive pots of sauce and pasta. At the end of the party, she had to lug both massive pots still full of pasta and sauce home. The lesson here is that we get confused with how much we can spend the more spending vehicles we have.

2) Incremental Rewards Diminish

Unless you are a billionaire, you only have so much money to spend a month. Let’s say your budget is $3,000 a month and you go from one rewards credit card to three rewards credit cards: one for travel, one for entertainment, and another for online shopping.

You must now calculate the incremental rewards you’ll earn, given you would have received rewards if you put everything on your one and only credit card anyway. Once you calculate the incremental rewards received, you realize the benefits aren’t that much at all since you are not spending 3X more by have 3X more cards. And if you are spending above your $3,000 budget that’s no good either.

Derivative Explanation: One friend started bragging about how his investment portfolio was up 18% in 2013. That’s a great return for anyone, but guess what? The S&P 500 index is up 18% as well! In other words, my friend created no alpha. All the time he spend researching and picking stocks was a waste since he could have just bought the S&P 500 ETF SPY and kicked back all year. To maximize your rewards from each card you’ve got to meticulously deploy your usage. Otherwise, you’re weighing down your finances with distractions. Real investors create alpha. Otherwise, you’re just a saver. Read: Are You A Real Investor If You Create No Alpha?)

3) Higher Chance Of Getting Into Debt

Credit cards have the highest interest rates for mass consumer lending other than payday loans. With the 10-year interest rate at 3%, the average credit card interest rate is roughly 15%. A 5X spread is enormous! No wonder why millions of credit cards are issued annually.

When you have more temptation to spend with more credit cards in your wallet, you will inevitably increase your chance of accumulating credit card debt. Just like how we don’t bring alcoholics to bars, we shouldn’t arm consumers who have a proclivity to overindulge on anything with more credit cards. Undisciplined spending and high interest rates compounded over time have a devastating effect on your wealth. (Read: The Reality Of How People Get Into Debt – It Just Creeps Up!)

Derivative Explanation: There’s a great study that showed a 30% increase in spending per customer once McDonald’s started accepting credit cards. One frugal friend I know went from buying two $1 McDoubles for lunch twice a week in cash to buying two $4 Filet O’Fish sandwiches and a large Coke three times a week for the next two years. He no longer plays singles because he went from a svelte 165 lbs to 200 lbs and admitted he’s got revolving credit card debt attributed to his fast food addiction.

4) Burden On Your Credit Score

We learned in my article on how to get a 800 credit score or higher that the Amount Owed accounts for 30% of your credit score calculation, while New Credit accounts for 10% of your credit score calculation.

Nobody knows exactly how many credit cards is too many, but one can imagine that after five credit cards, opening up another credit card at the margin will likely hurt your credit score, or at least not help your credit score. Sure there are plenty of examples of people who have eight credit cards and still have good credit scores. But perhaps they would have even better credit scores if they only had three credit cards.

Derivative Explanation: After three gin and tonics, I’m feeling good. After 10 gin and tonics, please dial 911 and pump my stomach before I die.

Focus On Bigger Picture Financials

Applying for multiple credit cards all the time is an unhealthy use of time. It’s like the person who always focuses on the emergency fund and not on ways to make more money. They never take their personal finances higher because they’re focused on kindergarten basics.

Everyone should have at least one rewards card given the benefits of travel insurance, rewards points, ease of use, and free interest for 30 days. My Citicard of nine years is now gathering dust given I want double points on everything with my Barclaycard. If I didn’t have a business, I wouldn’t have a third credit card. However many credit cards you have, be careful not to get caught in a negative debt cycle or damage your credit score.

Spend your efforts instead on building passive income streams and making more money. If you don’t have a highly addictive personality, one to three credit cards is the ideal number for optimal financial health!

Wealth Building Recommendation

Track Your Wealth For Free: In order to optimize your finances, you’ve first got to track your finances. I recommend signing up for Personal Capital’s free financial tools so you can track your net worth, analyze your investment portfolios for excessive fees, and run your financials through their fantastic Retirement Planning Calculator. Those who are on top of their finances build much greater wealth longer term than those who don’t. I’ve used Personal Capital since 2012. It’s the best free financial app out there to manage your money.

Planning for retirement when paying for private grade school — Are you on the right retirement path? There is no rewind button.

Looking for an awesome travel rewards credit card? Explore the top rated travel rewards credit cards today. The Chase Sapphire Preferred card is one of my favorites. It comes with a lot of benefits and rewards such as no foreign transaction fees, travel and purchase protections, and 60,000 rewards points after you make $4k in purchases in the first 3 months of account opening. That’s a $750 value in travel rewards right there! Check out my full review to learn more.

Updated for 2020 and beyond.

Pay Down Debt Or Invest? Implement FS-DAIR

Posted by Financial Samurai 77 Comments

The decision to pay off debt or invest is a personal one that depends on a lot of factors: risk tolerance, your number of income streams, liquidity needs, family expenses, job security, investing acumen, retirement age, inflation forecasts, and bullishness about your future in general.

I’ve had hundreds of people ask me this question about paying down debt or invest over the years. As a result, I’ve racked my brain for months to figure out a viable Debt / Invest framework solution that can be used by many.

The solution I’ve come up with is called, “Financial Samurai’s DAIR” or “FS DAIR” for short. The idea is to come up with something easy to remember, challenging, logical, and effective, much like the 1/10th rule for car buying to help folks maximize their wealth. Even though plenty of people have objected to my 1/10th rule for being too restrictive, I strongly believe the rule has helped people minimize financial regret and boost the incredible feeling of progress and financial security.

Since we are all CFOs of our finances, we need to figure out the most efficient use of capital. My goal is to make personal finance simple so ACTION can be taken. All talk and no action leads to nothing. I’d like to “DAIR” you to follow my debt pay down rule to achieve financial freedom sooner, rather than later.

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The Average Credit Score In America Is Now Excellent

Posted by Financial Samurai 53 Comments

The Average Credit Score Has Gone Up Dramatically Over Time

During my latest mortgage refinance, the loan officer said that he hadn’t worked with a borrower with under an 800 credit score in over two years.

I found this statement preposterous because I clearly remember during my previous refinancing that lenders would look for 720 credit scores or higher to provide the best terms.

Higher Scores Get The Best Rates

The first time we talked, one of the questions the mortgage guy asked was whether I had over an 800 FICO score in order to get the mortgage interest rate he was quoting, a 10/1 ARM at 3% with -2.75 points towards closing.

“Umm, I think so,” I responded with the might of a baby koala.

If I had said “no,” it felt like I would be wasting his time.

After our conversation I did what any good personal finance blogger would have done. Research into the veracity of his boldness. I was surprised at what I found.

But first, let’s do a refresher on credit score fundamentals.

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Average Interest Rate By Debt Type: Auto, Credit Card, Mortgage

Posted by Financial Samurai 52 Comments

Feel the debt burden

We are an indebted nation thanks to our desire for more and our financial system’s ability to grant us more. When used appropriately, debt can help provide for a better life and make us wealthier. When used indiscriminately, however, debt can destroy our financial dreams.

Below is a list of the most indebted nations according to Trading Economics. Currently, America is at ~106% debt-to-GDP and historically ranged from a low of 31.7% to a high of 122%.

Whenever your country’s debt is greater than its GDP, it’s probably a good idea to encourage your politicians to exercise fiscal restraint lest they take your country to hell during the next financial crisis.

Notice how many of the most indebted countries such as Greece, Italy, and Portugal continue to struggle since the 2008-2009 financial crisis.

Source: Trading Economics, Debt-to-GDP ratio by Country

Let’s review the following types of consumer related debt and rank them from worst to best. We’ll also take a look at the latest interest rate by debt type.

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