Be Cautious With Credit!

By “Awake!” correspondent in South Africa

IZAK and Mabel gazed at the bedroom suite in the shop window. Mabel’s eyes glowed as she noted the elegant bed cover and the attractive dressing table. But her face fell when she saw the price​—R555,55.a For Izak, an office cleaner, and Mabel, a domestic servant, that was far too much. They could never save that amount.

Mabel was about to walk away when she saw another ticket. It said: “10% Deposit​—R25 per month.” She began working it out: “Only R25 per month! Surely by saving here and there, or doing some extra work, we could manage to pay that. Perhaps we could get this bedroom suite now, without first having to save up.”

As she was thinking it over, a smiling salesman approached. Izak and Mabel were ushered into the store.

Mabel asked: “How long would we have to pay the R25 per month?”

“Two years,” said the salesman.

Mabel worked it out slowly on paper: R25 per month for 24 months. Total​—R600. The deposit was R55,55. Thus the bedroom suite would cost them R655,55 instead of R555,55.

“Why the extra R100?” she asked.

“That’s the amount you pay on interest because you are buying on credit.”

“It seems like a lot,” complained Izak.

“No,” explained the salesman, “it’s only 10 percent per year. And 10 percent of R500 is R50. For two years that’s R100. That’s not much for borrowing the money for two years.”

Izak thought about it. Mabel was obviously keen about getting the furniture now. He was satisfied.

But should he have been? While 10 percent interest a year did not seem too high, actually he would be paying interest at a far higher rate. How so?

The salesman had quoted to Izak the “add-on,” or “flat,” rate. This is calculated on the full amount owing at the time of the sale. However, Izak would not owe this amount for the full two years. After each monthly installment he would owe less. But he would be paying interest as if he owed the full R500 throughout the entire two years. Calculated on what he would actually owe each month, the interest he would pay would amount to over 18 percent per year, not 10 percent. This actual rate of interest is also referred to as the “effective” rate. In many countries the interest charged on installment sales is much more.

So if you are buying on credit under an installment arrangement, ask what the “add-on” and “effective” rates are in your country. Usually, the “effective” rate is the actual rate you would pay if you borrowed the money from a bank.

Cash vs. Credit

Obviously, buying on a credit plan means paying more. Could Izak and Mabel have saved even more money by waiting until they had cash?

The owner of the store may mark up his goods 100 percent or more. This means that an item he buys at R100 would sell for R200. But with such a large gross profit the storekeeper may feel that in order to make a sale he can offer a good discount for cash.

Thus, if Izak and Mabel could have offered spot cash for their bedroom suite they might have been able to bargain with the storekeeper for a 10 percent, or even a 20 percent discount on the price, thus saving them over R50 or R100.

Thus, before buying their furniture through an installment plan, Izak and Mabel should have considered not only (1) the high rate of interest they would have to pay, but also (2) that they would lose any discount they could have obtained by paying cash.

Then, is buying on credit wrong? Not necessarily. It is a personal decision. Very few families can buy things such as a home, or even an automobile, without getting credit. True, in the case of the automobile, some might feel that they would want to save the money ahead of time and then pay cash. But, in some cases, this could take several years. By that time inflation likely would have caused the price to go up considerably, wiping out much or all of what could have been saved by not buying on credit.

Thus, some may feel that there are advantages in buying on credit, such as: (1) having the immediate use of the goods; (2) no price increase due to inflation; (3) complaints often attended to more promptly since good relations are desired with the customer because he still owes money; (4) monthly payments can be taken as a sort of compulsory saving.

Less Costly Credit

In addition to an installment agreement that includes interest payments, some places have less costly forms of credit.

(1) Monthly payments treated as a cash agreement. Some stores allow customers to pay just the original price by monthly installments over a period of time, say, six months. No credit payments are involved. This is the least costly method of credit buying. However, usually there is no possibility of any cash discount.

(2) Bank overdraft. If your standing with a bank is good, in some places you can borrow money for credit purchases by drawing from your account more than you have, with the bank’s approval, of course. In South Africa, at the moment, the interest charged on a bank overdraft is less than the interest on an installment sale agreement. Interest is charged only on the actual amount owed. If you are able to pay off your debt more quickly, you pay less interest.

(3) Credit Cards, such as a bank credit card. The basic use of a credit card is for obtaining goods and services that are paid for during the following month. But with many credit cards it is possible to make larger purchases with payment being extended for one or two years. The monthly payments include considerable interest. If you are able to pay off the debt more quickly, interest payments are less, as with the bank overdraft. But again, when buying with a credit card, it is difficult to negotiate a cash discount.

Be Cautious About Credit

Before obtaining a credit card, it would be well to ask: “Could having such a card be a danger and introduce additional stress into my life?” Many have found that having a credit card encourages impulsive, unnecessary buying, resulting in financial problems and worries.

Such a word of caution applies not only to credit cards but to all buying on credit. It can be argued that no form of credit is cheap, that it increases costs and fuels inflation. Shakespeare said: “Neither a borrower, nor a lender be.” Before him the inspired Bible writer warned: “The borrower is servant to the man doing the lending.”​—Proverbs 22:7.

It would be highly preferable if one could go through life without any debts. However, this is not always possible in today’s world. Yet caution should be exercised, realizing that credit is money. Your ability to pay back is limited by your disposable income, that is, by what remains of your income after all other expenses have been paid.

If your total repayments for credit purchases exceed your disposable income you will experience problems and unhappiness. In Charles Dickens’ novel David Copperfield, Wilkins Micawber declared: “Annual income twenty pounds, annual expenditure nineteen pounds, nineteen shillings and sixpence, result happiness. Annual income twenty pounds, annual expenditure twenty pounds and sixpence, result misery.” Yes, the difference between happiness and misery can be spending one shilling too much!

Particularly is it unwise to use long-term credit for nonessential luxury items of a perishable nature, where the goods are used up long before they are paid for. Even when inflation is taken into account, saving for a purchase and then paying for it is often cheaper and more satisfying. It also means much less anxiety.

If, like Izak and Mabel, you decide to buy on credit, use it for essential purchases of a durable nature. Learn what types of credit are available. Choose the least costly. In a word: be cautious with credit.

[Footnotes]

[Chart on page 14]

Actual cost using installment credit 655.55

[Chart on page 15]

Credit payments should not exceed your DISPOSABLE income