Understanding credit’s long-term impact

Credit is evil. That’s a phrase I’ve often used when speaking to groups. It always elicits laughter, even from people who pay off their credit card balances every month and enjoy reward points for their frequent business.

Why do people laugh?

Is it because the phrase is so ridiculous? Can credit itself — the lending of funds to individuals or companies or government — actually be evil?

It sounds preposterous because the use of credit has become so ingrained. Most people can hardly escape it. We borrow to buy everything. You can even use a credit card to pay your tax bill.

But in many cases, the things purchased with credit have long been consumed or tossed out, while the debt lingers on.

I’ve been having a lot of conversations about credit lately because April is Financial Literacy Month, a time when consumer advocates, regulators and, yes, even financial companies attempt to help people manage their money and credit better.

There’s been a lot of academic research on consumer behavior as it relates to credit. Adding to that examination is a new book, “Consumer Credit and the American Economy,” by Thomas A. Durkin, Michael E. Staten, Gregory Elliehausen and Todd J. Zywicki.

“We all think we know about credit, but do we?” the authors ask in the preface of the book. They then spend 710 pages, including a lengthy index, dissecting consumer credit and its history. This is not light reading, although it’s thoroughly enlightening.

One passage early in the book really stuck with me.

“Most purchases on credit could be accomplished by accumulating cash first and then buying the item later, but this often is not the time pattern consumers prefer,” the authors write. “For many goods, accumulating cash first could mean doing without the item or paying for more expensive substitute services for a period that might amount to years, both of which are costly.”

That observation is the crux of credit. It begs the question: Is credit helpful or harmful?

Actually, I believe it’s both.

Credit has been most helpful in enabling families to become homeowners. And it’s through homeownership that many Americans build wealth. So yes, the ability to borrow has propelled many families into middle-class status.

But credit has also pushed families to their financial limit. They bought things when they should have waited until they had the cash.

I often focus on people who use credit to live above their means, chastising them for being irresponsible. But I see a lot of people who are living right at their means.

And here’s the distinction: Yes, they can make the credit payments. Technically, by the measures used by lenders, they can handle the debt load based on their income — gross, not net, I might add — on top of their other debt obligations. On paper, they don’t appear to be living above their means.

But if anything goes wrong — an illness, divorce, job loss — these folks are living on the edge.

Instead of saving more, they’ve paid the cost to maintain that consumer debt. It’s much easier to ride out a financial crisis if there isn’t debt to carry.

As an experiment, I once asked people in a financial program at my church to jot down from memory everything they had bought on their credit cards in the previous three months. Then they had to compare their memory to the credit card statements. They remembered the big things — a car repair or new couch — but they couldn’t recall many other purchases.

You see, I don’t use the word evil as a literal condemnation of credit. I use it to jar people into realizing how harmful credit can be if they aren’t careful. It’s my extreme way to get them to question every single consumer credit decision. Can you wait? Can you spend less?

I see the effects of credit when I teach and coach people one-on-one and in groups. I have worked with people who either used credit recklessly or were the victims of predatory lending. I’ve also seen the results of people who overestimated their ability to handle their credit cards or loans.

So I’m on a mission to sound the alarm about credit and to help consumers understand the consequences of indebtedness. Today, you may be able to handle it. But what about tomorrow?

In “Word Origins,” author John Ayto says evil can be translated as “exceeding due limits.” Isn’t that exactly what many consumers do when they use credit? In good financial times and bad, they exceed what they should spend because they can.