Monday, March 15, 2010

Concept of Credit in US: Good or Bad?

(This blog post is written by my friend Miles Costanza. Miles writes about the whole concept of credit and credit score in US and how it can potentially land you in trouble.)

Is credit in America really adding value to our society or is it really only a tool for banks, and though media brainwashing, we have adopted it as something as personal as our family name?

Here’s a short fictional tale of two individuals who want to buy a car. Let us assume V has excellent credit, and B has bad one. Both have the same amount of income and a small cash reserve of a thousand dollars to put towards the car. They also have the same earnings and expenses.

V goes to the car dealer, and easily is approved for a loan with his credit score. The banker looks at his income and expenses and determines the amount of extra cash he has to spend each month on a car payment. It’s a close estimate – only a couple hundred dollars above of what he can actually afford. After all, the banker knows nothing of his lifestyle; that is not in the equation. The dealer shows him all of the polished, impressive, girl-attracting cars strategically placed on the lot. Knowing that he has good credit and extra income, he wants to show off, as society encourages, so he drives home feeling good in a new bright red BMW. He knows it will impress.

The next day B goes to the dealer (thank goodness they have another identical red BMW to attract him). But poor B has bad credit. His little down payment won’t help. He has to face his worst fear – riding the bus and saving money. For the next year he rides the bus and saves his extra income. Finally he has enough money to buy a used car outright. Though not as impressive, he buys what he needs to get the job done. No extras for B. He drives home also feeling good. Not because it will impress, but because he has worked hard and earned it. He now knows the value of money. He is actually glad he didn’t buy a new BMW, and would never do so, now that he understands how much effort went into saving for the used car.

In the mean time, V’s employer has gone under. He was laid off one day without warning. Despite his hard work, he is left without any income except for the $240 weekly unemployment check. Just enough to almost pay 2/3 of his mortgage. He is skilled and qualified, but despite this unable to find a job in an unstable economy. He draws out of his 401k under “emergency” pretences, an investment that has lost much of its value. Despite the guaranteed loss in value and the penalties for the withdrawal, he takes his saving for pennies on the dollar to keep himself above water for a few more months. Finally its exhausted and his temporary job at Circle K doesn’t pay enough. Even with the extra hours. He has to sell the house and car. Sadly, both have lost so much value, he owes more than they are worth. He can’t pay, he can’t sell. The bank takes them away. In return he gets what they promised: bad credit. They brand him with this bad credit to remind them never to loan money to such an irresponsible person again.

B also lost his job. But only because he has no car payment, he is able to use his car working for a courier and make ends meet (they pay more than Circle K). The bank rewards B with good credit. This is the kind of guy that should be buying a new bright red BMW. Make you own conclusions. Post it as a reply.

Photo Courtesy Click Here

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OpenID vishal12 said...

It looks like this post is more about 'should one buy a used car or a girl-attracting [you know there's a word for that, don't you!] new car'? I mean, if V went for a used car, wouldn't both V and B end up in the same boat?

There seem to be inherent differences between V's and B's psychology. If so, you are comparing apples and oranges. And if not, you're making an implicit argument the change in psychology is CAUSED by the availability of credit, then that's a different ball game altogether (which can easily get into chicken-or-egg type argument).

March 15, 2010 1:36 PM  
Blogger Karthikeyan said...

I would agree with vishal12. I don't think this post is about credit, let alone whether it is good or bad.

Maybe the author could move this thread along by posting a few more reasons on why he thinks it's a good or bad choice here. A hypothetical example can be used to explain an argument but that itself cannot be used as an argument one way or the other.

March 15, 2010 4:43 PM  
Blogger Jijo VG said...

different thought !!

March 15, 2010 7:36 PM  
Blogger Jijo VG said...

Different thought!

March 15, 2010 7:36 PM  
Blogger Miles said...

"you're making an implicit argument the change in psychology is CAUSED
by the availability of credit"

My response:
Very good observation. This is exactly what I'm doing. This is the
entire point of the story. I wanted the reader to figure it out so he
would think about. See the marketing that is commonly used - the next point I was hoping the reader would think about but I didn't write - "buy it now... pay later... you deserve it..."

March 16, 2010 2:54 AM  
Blogger Miles said...

I'm not making any argument here. I wanted to inspire critical thinking. Credit is not good or bad - it's merely a statistical tool to predict an outcome based on past events.

It's how this seemingly arbitrary, unitless number has changed the way we think about savings and spending that is interesting. It really has changed our way of life.

March 16, 2010 2:58 AM  

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