There is a lot of discussion about Good Debt vs Bad Debt. Good Debt is debt that can earn money while Bad Debt loses money. Common examples of Good Debt are loans to start a profitable business, loans for education to improve your earning potential, or loans to purchase real estate or other assets which can appreciate. Credit card debt, with its sky-high interest rates, usually falls in the Bad Debt category. Many famous financial gurus such as Suzie Orman and Dave Ramsey are always warning against credit card debt and for good reason. Some gurus even advise people to avoid credit cards all together. Americans pay an amazing $120 Billion in credit card interest and fees each year. Credit card companies and banks are constantly scheming new ways for everyday people to spend more money and get into debt. However, if used right, even credit card debt can be Good Debt.
Some people have started businesses using credit cards for startup capital. While there are examples of people who have started successful and profitable businesses using credit cards this is an extremely risky last ditch tactic which incurs significant personal liability. If the business does not succeed, the high credit card interest rates and personal liability will almost guarantee a personal bankruptcy.
With a little twist in thinking however, almost everyone can easily benefit from credit card debt. It takes no complicated strategies or advanced education. All it takes a little personal restraint, discipline and a change of view. Use your credit card for everything you can and pay off your credit card every month. It is just that simple.
Ever since I got my first credit card in college about 30 years ago, I have charged everything I can to my credit cards. Like many Americans, I love my credit cards. Unlike many Americans, I have also paid my balance in full every month and very rarely pay any late or interest fees. There have been a few times where I used a free zero percent balance transfer offers to carry a balance longer than a month and while I have not kept close track, I would be surprised if I have paid more than $100 in credit card interest fees in my life, always because I simply forgot about a due date. This is through a career where I never made anywhere close to six figures and had some long periods of unemployment, some lasting over a year. I simply made sure I lived within my means and prioritized paying off my credit cards.
Since I charge everything, I always have a balance of $2,000 – $4,000 on my credit cards. That is just my normal month-to-month expenses. Sometimes I my balance is less, sometimes more but for the sake of simplicity, let us say my balance is $3,000. Regardless of the amount, I pay it off every month but my revolving balance does not vary much over time since I am always charging new stuff.
Let us assume I have average $3,000 revolving balance on my no annual fee credit cards at all times. $3,000 a month is an amount that most normal people can charge for their everyday expenses such as food, gas, insurance, purchases, etc. I pay no interest because I pay it off in full every month and charge a new $3,000. The credit card company has effectively loaned me $3,000 for free. Now here is the important part. If I take that $3,000 and invest it, for example putting it into a low cost S&P 500 fund which has a long term average return of 8%, I would have over $30,000 after 30 years. Therefore, by simply using my credit card for normal everyday purchases and paying it all off every month, I have a gain of $30,000 over 30 years. Sounds like good debt to me.
Here is a hypothetical example to illustrate the idea. Let us say I live in a rent-controlled apartment that charges $3,000 a month. We assume the rent will never change and since my rent will never go up, I am going to stay for 30 years until I am forced to move to a retirement home. We also assume that I am financially stable, have an emergency fund and am looking to move towards financial independence.
Every first of the month I have been paying my rent in cash. I get a notice that starting January 1 of the next year my apartment will accept credit cards as payment without any extra service fees. January 1, instead of paying cash as I had before, I charge the $3,000 rent to my credit card. I take the $3,000 cash that I would have paid in rent on January 1 and invest it in a low cost S&P 500 fund that historically has earned an average of 8% a year over the long term. This can be a direct investment or for even more benefit I can do a one-time extra 401k contribution at work. Once again, this is the most important part, if instead of investing the money I take that extra $3,000 in cash and buy a new TV or take a vacation, the whole concept fails.
My credit card statement closes on January 31 and I get my credit card bill that will be due in 15 days on February 15th. On February 1st, I charge my February $3,000 rent to my credit card and my credit card balance goes to $6,000. On Feb 15th I take the $3000 rent cash I would have normally paid on February 1, pay the credit card dropping my balance back to $3,000 and avoiding any interest or fees. On March 1, I charge my rent again to the credit card and on March 15, I pay off the credit card. This continues for 30 years and I have effectively gotten that $3,000 as an interest free loan until I move out of the apartment, 30 years from now. At that time, I will need to pay the $3,000 back, one month after I move out. After 30 years, that $3,000 invested at 8% will become over $30,000.
It gets even better. Usually even no annual fee credit usually offer at least 1% in points or cash back. $3,000 charged every month for 30 years comes out to $1,080,00 dollars or at least 1,080,000 points. Many cards offer higher percentages such as 5% in various categories but for ease of math let us just use a simple 1% cash back. 1% cash back on that amount would be $10,800. This is a base, no brainer amount you will get without using any credit card strategies that could easily earn five or ten times more value from the points.
Combine the approximately $30,000 earnings from the $3000 free loan with the $10,000 worth from the 1% cash back you get at least $40,000 over 30 years. An extra $40,000 towards retirement is a pretty decent amount for someone with $3,000 monthly expenses, especially since it takes practically no effort at all. This could shave a year off your retirement date. The higher your normal monthly expenses, the larger the savings so the effect scales. Imagine if you had a small business that had $30,000 monthly business expenses that you could charge. Of course, all of this depends on buying only what you need and paying off your bill every month. Spending frivolously, living beyond your means or not paying your bill in full every month will guarantee disastrous results and have led many people to bankruptcy.
Of course, most people already use credit cards and have had a running balance for a long time. What happened to that initial money, whether invested or spent happened a long time ago. Perhaps though, we can all adjust our perception of credit card debt a little. If we can adjust our relationship with debt we can turn what many consider a negative into a positive tool to further our financial goals. If used correctly, credit cards are easiest, most accessible way that almost anyone can get an interest free loan and that is something very special. In fact credit card companies offer bonus incentives for giving them the opportunity to give you the interest-free loan.
Many people in the FIRE community hate debt, especially credit card debt. One poster on a FIRE message board was so against debt that they stated emphatically that they would reject a one-year $100K interest free loan with even if no other strings attached. However, if they took the loan and put it into a simple 1 year US Treasury bond currently paying 4.55% they would have made $4,550 profit by the end of the year. They would rather forgo the certain profit to avoid being in debt.
We can achieve our financial goals faster and more efficiently if we think of debt like the truly wealthy think about it. The wealthy do not even call it debt. They call it leverage or financing and see it as a tool to build their financial projects. The truly wealthy consider debt a tool with many uses from using it as leverage to increase profit, reducing liability by transferring debt to a company or to others, reducing taxes with tax write offs, using loans on assets to avoid taxes, even managing wealth transfer to heirs. The truly wealthy love nothing better than to make money using OPM (Other People’s Money).
By re-evaluating our ideas and relationship with debt we can better achieve our financial goals. Debt, while it can be dangerous, can also be a powerful tool to financial freedom if used correctly and this can even include the much maligned credit card debt. If you are prudent person, perhaps you can adjust your thinking and move the idea of credit card debt from the bad category to the good.