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The True Cost of Debt and Alternatives to Debt

Posted by Brandes Elitch | Sat, Mar 11, 2017 @ 10:00 AM

true cost of debtToday we’ll take a look at three types of debt, the true cost of debt, and discuss how to be smart about taking on debt.

First, let’s look at having a mortgage for your house. About 63% of Americans have a house and most of them have a mortgage. The Federal Reserve Bank of St. Louis reports that the median sales price of a new home is $316,000. Obviously, most people wouldn’t have that kind of money in liquid assets, so they would need a mortgage. Another way to look at it is if you want to build a 2,000 square foot house, it will cost you at least $150 a square foot, which is $305,000 right there. Aside from being a kind of “forced saving,” a mortgage has another benefit: it is also “preferred debt.” This means that the interest is tax-deductible. Contrast this with non-preferred debt, such as revolving credit card charges, car loans, and student loans.

For the purposes of illustration, let’s assume that you live here in Sonoma County, California, where CrossCheck is located. The median home price here is almost $600,000 — yes, really — and that’s a lot cheaper than San Francisco about 50 miles south of us.

Let’s say that you are fiscally conservative and decide to have a 50% mortgage for your $600k home. You get a fixed rate of 3.875% and it is a 30-year term. Your monthly payment is $1,410 and you can deduct the interest, which is typically higher at the beginning of the loan, on your tax return. So in a sense, you could say the government is subsidizing the cost of your loan.

The second most common form of debt is a car loan. The average new car is currently around $33,000. Edmunds reports that the average used car costs $18,600. Let’s say you get a used car and take out a $10,000 loan. You get a bank loan for six percent, which makes your monthly payment $500 (about a third of your mortgage, but not tax deductible).

Now let’s look at your credit card balances.  About 75% of Americans have a credit card of some kind, and roughly half the cardholders revolve their balances. In other words, they don’t pay off the balance in full each month. The average person that has a card has three or four other cards as well. The average revolving credit card balance is $16,748. Let’s say that between your cards, you own $8,000 (you’re fiscally conservative), at an average interest rate of 16%. You pay $400 a month to revolve these balances, almost as much as your car loan.

For these three loans, your total monthly payment is $2,310 or $27,720 annually. The median household income in the country (2015) is $56,516, which means that with sales tax (about 8 – 9%), state income tax (here in California, the top marginal rate is 13.3%), and federal income tax (10 – 39%), social security tax, medical insurance and car insurance, there is not much left at the end of the month — a pretty familiar scenario for many of us.

The Wealthy Hand-to-Mouth

In fact, there is even a category called the “wealthy hand-to-mouth,” which consists of people making over $100,000 a year with equity in their house and savings in their 401K plan, but little or no disposable income at the end of the month. A recent article by Allison Schrager in Qz.com, explains why.

The average 40-55 year old with a household income of $75-$100k typically has about $70k in financial assets that aren’t a house, car or business. About 25% have less than $17.5k. Typically, most of the funds are tied up in retirement plans, which cannot be tapped without penalties. Excluding those plans, the average upper-middle-class household has only $12,200, and about 25% had only $3,200 saved. Now you see what I am talking about!

Now, life happens. The transmission in your “new” used car starts slipping right after the 90-day warranty expired. Automatic transmissions are expensive to repair, typically about $3,500, unless you own a “prestigious German import,” in which case it will be significantly more. The easiest thing to do is to just charge it on a credit card if you have an “open to buy” in that amount. So now you are revolving $11,500 on your cards.

Now, if you add up all the interest charges you are paying, it is a staggering $14,065 annually, so the true cost of debt is about a quarter of your income. And as most people who are revolving credit card balances know, short of refinancing your mortgage for debt consolidation, those card balances never go away.

CrossCheck’s Alternative to the True Cost of Debt

How can CrossCheck help?

After doing millions of transactions over the last 30 years, we have devised a service that helps the consumer manage the true cost of debt. It is called Multiple Check (aka “hold check” at large) and here is how it works.

When you are standing in the transmission repair shop (and we have hundreds of them as clients), you can tell the shop owner that you would like a few months to pay the bill, and you would like to choose the dates when the payment happens. You also don’t want to apply for credit, and you don’t want to pay any interest. You just need some extra time to come up with the money, but you don’t want to put it on a credit card.

In the old days, retailers called this “90 days same as cash.” We have found that when we give the consumer some extra time to come up with the money, they can do it about 95% of the time!

So CrossCheck stands in at point of sale and authorizes those future payments for the merchant so they don’t have to worry about those checks bouncing. And when this happens, the consumer is not adding more debt to their credit card balances. We think this is a good thing, and so do consumers and merchants.

There are no gimmicks or hidden fees or retroactive interest charges. If you are a transmission shop, or car dealer, veterinary office, funeral home, building supply company or any other type of business that takes high-dollar payments, ask CrossCheck to create a plan for you and your customers. We’ll make a sale happen for the merchant, and keep the consumer a little less in debt!

Multiple Check Insider's Guide

Topics: Brandes Elitch

Written by Brandes Elitch

Brandes Elitch is Director of Partner Acquisition for CrossCheck Inc. A certified cash manager and accredited ACH professional, he garnered a Master of Business Administration from New York University and a Juris Doctor from Santa Clara University.