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Cedric Pariente

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Cedric Pariente - Racine Alpha

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Credit Without a Purpose is Dangerous!

26 January 2010  |  5225 views  |  1

Do you know the Real Definition of Credit ?

Credit is a reserve of money granted to you, usually by a bank, that you will have to repay over a predefined period of time, but that you can use immediately. And you are paying an interest in exchange of this service.

This money or what you buy with it is NOT YOURS until the loan is fully reimbursed.

 

The French Model

In France people are afraid of credit. Yes, Afraid!

Why? Are they more conscious of what credit really is?

NO. But the credit system is and has always been tough in France. It’s hard to get a loan and you don’t want to miss a payment, otherwise problems start very fast. This is why they are so careful when it comes to credit.

 

Credit without a Purpose is Dangerous!

In France people usually finance two things with a loan: Their house and eventually their car.

The main loan represents usually 80% of the price of the house and is contracted over 15 to 25 years.

The second loan for the car is much smaller. Very often it’s a small line of credit that represents 90% of the price of the car over 2 to 5 years.

THAT’S IT!

There is no second mortgage, no home equity loan, NOTHING ELSE!

How do French people live?

They use a very simple rule:

Wealth = [What you earn] – [What you spend]

As long as what you earn is bigger than what you spend, you’re on your way to go out of debt and reach financial freedom.

 

Debit & Prepaid Vs Credit

Pros

 

  • Credit: Loyalty Programs
  • Debit & Prepaid: Control

Cons

  • Credit: Motivates Impulse Spending
  • Debit & Prepaid: Less Flexibility in Spending

Loyalty programs are the most interesting thing about credit cards. They also lead to the most dangerous part of the credit card: Maxing out on your Credit Limit.

 

You cannot see the danger until you max out. And once you’ve maxed out all your credit cards, good luck in coming back to financial solvency.

With Debit & Prepaid, you’re always in Control. No matter what happens, you cannot increase your debt. The warning signs arrive earlier. And with a prepaid, you cannot have an account with a negative balance, meaning you cannot spend money you don’t have. And that’s a good thing!

 

Why is it important to use less Credit in a Crisis Context?

Today more than ever [What you earn] and [What you spend] are at risk because of:

 

  • Uncertainty in employment
  • Rising Credit Card interest rates
  • Increase in prices of bank services

You need to constitute an emergency fund, ensure your retirement plans will be fulfilled and save money by either spending less or at least spending wisely.

No Bail Out for Individuals

 

Remember, each type of card is a means of payment with its pros & cons.

Even Credit cards can be interesting if you use them with extra-care.

Be wise. There is no such thing as a free lunch. The benefits of loyalty programs with credit cards are certainly interesting but only if you pay your entire credit card balance. If not, the interest charges will surely eat these benefits away.

Moreover buying because of a discount when you don’t need what you are buying is penny-wise but pound-foolish.

 

No Usury Limits for US Banks

I have recently learnt about the inadequacy of usury law in the United States of America.

How surprised was I when I saw that in 1980, the US congress passed the Depository Institutions Deregulation and Monetary Control Act[i] EXEMPTING federally chartered savings banks, installment plan sellers and chartered loan companies from state usury limits.

Basically, banks can charge ANY INTEREST RATE at will.

In France, the Usury Rate is published quarterly by the Banque de France. It depends on the type of loan but it fluctuates around:

 

  • 20 to 22% for loans above 1 500 EUR
  • 8 to 12% for loans below 1 500 EUR
  • 6 to 8% for mortgages

 

In the US, the average interest rate for credit cards is supposedly 12 to 16% but more and more US consumers have reported unexpected increases of their credit card interest rates.

The highest rate ever seen so far is a card offered by First Premier Bank carrying a 79.9%[ii] interest rate. And just recently, a San Diego lawyer threatened to sue Bank of America after it raised its interest rate on his credit card account to 27.9%.

Usury is a complicated area of law on which US Banks have a very comfortable position. Back in 1980s they pretended that inflation was the reason why this law was voted. Maybe now is the time to re-evaluate it and have interest rates on car loans and credit cards that are reasonable.

 

Shifting Away from Credit and Overdraft Fees

There were 34 billion U.S. debit card transactions in 2008, totalling $1.33 trillion. That's way up from 16.1 billion transactions totalling $583 billion in  2003. (Source: Nilson Report, December 2009)

Debit cards are now preferred over credit cards by American consumers who use plastic for their in-store purchases. Spending on these cards, which directly takes the money from your checking account, accounted for about 58 percent of purchases made with plastic in 2008, and are expected to account for nearly 60 percent in 2009, according to The Nilson Report, a trade publication that covers the payment industry.

But research shows that consumers who use debit cards more often are also more likely to overdraw their checking accounts. Customers don't realize that they'll be charged a fee, which averages nearly $30 for overdrawing on their checking accounts.  The group estimates that consumers pay $17.5 billion in overdraft loan fees annually—nearly half of which are triggered by debit-card transactions or ATM withdrawals. In this context, prepaid debit cards enable cardholders to avoid overdraw conditions.

The trend that we see is the continued increase in debit card usage as well as prepaid debit cards that will have something to offer better than debit cards.

 

[i] http://en.wikipedia.org/wiki/Usury

[ii] http://www.huffingtonpost.com/2009/12/17/799-percent-interest-cred_n_396191.html

 

Original Post:

http://b32trust.blogspot.com/2010/01/credit-without-purpose-is-dangerous.html

 

a member-uploaded image TagsCards

Comments: (2)

A Finextra member
A Finextra member | 27 January, 2010, 09:28

But research shows that consumers who use debit cards more often are also more likely to overdraw their checking accounts. Customers don't realize that they'll be charged a fee, which averages nearly $30 for overdrawing on their checking accounts.  The group estimates that consumers pay $17.5 billion in overdraft loan fees annually—nearly half of which are triggered by debit-card transactions or ATM withdrawals. In this context, prepaid debit cards enable cardholders to avoid overdraw conditions.

How is it possible to overdraw your account with a debit card? If I recall correctly, there is a "balance checking" feature in debit card systems that refuses your purchase if there are not enough funds to cover the transaction in your account. This should work with purchases but at least in withdrawals from the ATM...

 

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Cedric Pariente
Cedric Pariente - Racine Alpha - Paris | 27 January, 2010, 10:51

Hi Kalle,

Most of the debit cards (in France & in the USA) have an "authorized" overdraft by default.

For example on my french debit card I'm "allowed" an overdraft of 3 000 EUR.

Which is a semi-credit. Meaning you pay a smaller interest than for pure credit. But still... you pay.

On Prepaid cards, it is technically not possible, as the prepaid cards system is not offering a credit or semi-credit possibility. It is really your money that you are spending. The "pre-negociated" overdraft does not exist.

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I'm Cedric Pariente, a Stanford Certified Project Manager, working in both IT and Market Finance.

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