Wednesday, October 21, 2009

Credit Buyers are Undisciplined Consumers

Buying things on payment plans is an insane idea. I know, what I am saying is practically un-American, but nevertheless that's where I stand. A great example of that all prevalent insanity is car payments. A car is the classic depreciating asset - you buy it today and it's value can only go in one direction: down. However, tens of millions of Americans buy their shiny, cash draining machines on credit, burdening themselves with financing changes and negative cash flows. Some would say that they have to buy a car on credit because they can't afford to buy it straight out. If you can't afford to buy your car with cash, you can't afford to buy it on credit either. You can't afford to buy that Lexus? Spend $8K and buy a second hand compact car. Believe me, it will get you to work and back, just like that fancy car would. Yes, I know, you won't look as cool, but think of all that cash rattling in your piggy bank.

Are all payments bad? Of course not. Credit is a good thing if it is used for the right things, and there are primarily two types of things that are worth buying on credit: (i) appreciating assets (or at least ones that are not expected to lose value) - a house is a great example that falls into this category; and (ii) assets that generate a positive cash flow after the financing charges - for example, a profitable business.

Financing consumption through credit payments does not make your consumption more affordable, it simply robs your future self to pay for things you want today. Show me a payment buyer and I will show you an undisciplined consumer.

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Ren said...

While I basically agree with what you've expressed here, I feel the need to point out that there is a difference between financing a depreciating, yet utilitarian, asset and financing a non-asset (consumables).

If you are going to get use from an asset for at least as long as the financing, then it isn't really stealing from your future.

For example, if you are just starting out, have no savings, and need personal transportation for work, your only viable option may be to finance a vehicle. That being said, you would certainly be better off with very short-term financing of an inexpensive used vehicle.

In a similar vein to what you've said, I'd also contend that if you can't afford to replace/repair a single major component of your vehicle, then you can't afford the vehicle.

Shadox said...

Ren - I think we are pretty much in agreement on this issue, maybe minus some nuances.

If someone is starting out and needs a car to get to work and has no savings to buy it out right, clearly financing is a good option. However, in that case, they should finance the cheapest vehicle that suits their needs (vs. finance a car that suits their desire to look awesome in a beemer...)

I just don't get people in my office, for example, who make WAY less money than me, but drive fancy cars for which they are paying through the nose. Don't get it.