power your advice

Feeling Too Popular? Talk to Clients About Their Debt

“Money talks. It says goodbye.” In the last couple of weeks, we have seen pullbacks in the stock market tied to concerns about the Coronavirus. Clients don’t need to hear “Easy come, easy go.” They are seeing what volatility can do to paper profits. It’s time to put on your protective clothing and talk to clients about their consumer debt load.Many Americans carry credit card debt. According to a 2019 nerdwallet article “2019 American Household Credit Card Debt Study” (1) the average American household has $ 6,849 in revolving charge card debt. The key word is “revolving.” This is the part that doesn’t get paid off. The article indicates it costs those households $ 1,162 in annual interest. Divide the smaller number by the larger number and you get an interest rate of about 17%. Why Clients Should Pay Off Credit Card Debt Some clients have some pretty good profits in the stock market. In 2019 the S&P 500 was up over 30%. Assuming these funds are it taxable accounts, debt reduction is a good strategy. Here’s why.

  • It “never” goes down. Stock prices rise and fall. For most people, credit card balances only rise. They might make minimum payment, but they keep using those cards, increasing their balance.
  • Interest rate increases get passed along immediately. Years ago, I heard an observation about gasoline prices at the pump in England. “They go up like a rocket and come down like a feather.” When the Federal Reserve increases rates, your bank isn’t compassionately saying: “Let’s give people a break and hold off.” No, they pass it along immediately. Rates on outstanding balances go up.
  • Don’t miss or be late of payments. There are other bills consumers might stretch out. I doubt if lawn mowing and trash collection bills get paid promptly when money is tight. Miss payments on your credit cards and you enter the world of penalty rates. These can be up around 29.99%. (2)
  • Credit rating. Get into trouble with your credit cards and you damage your credit rating. Although you might not be planning on borrowing any more money, Nerdwallet indicates 25% of company HR departments perform credit checks on job applicants for some positions and 6% check on all positions. (3) A poor credit history can hinder getting a better job.
  • 17% vs. 7%. According to Bamnkrate.co, as of 2/3/20 the average home equity rate in the US is 7.29%. (4) According to creditcards.com, for the week of ½29/20, the average credit card rate was 17.31% (5) You might ask how banks can get away with charging ten points more on one product than another. The answer is much more complicated, but the simple answer is. “Because they can.”
  • Paying as much as you spend. Many clients probably aren’t spendthrifts. If they kept track, they might discover they pay the credit card company about as much as the ran up in new charges. That’s great, except it doesn’t pay down the revolving balance,
  • Credit card interest isn’t tax deductible. It was once, before the Tax Reform Act of 1986. (6) Then it wasn’t. Ronald Reagan was president. Bottom line, today you are paying that 17%+ interest carry charge with after tax dollars.
  • Available credit is not an extension of your salary. Some people think they should use it just because it’s there.
  • Paying off debt with your bonus. The above logic speaks to spending more now and then clearing up the debt when your annual bonus comes in. The debt is certain. The bonus often isn’t. Quite often we think of more fun things to do with the bonus. The debt stubbornly remains.
  • We’ve heard the analogy of the Federal Reserve taking the punch bowl away just as the party is getting started. If markets run in cycles, try to encourage clients to eliminate as much debt as is practical when times are good. It’s not a fun conversation, but it’s necessary.(1) https://www.nerdwallet.com/blog/average-credit-card-debt-household/(2) https://www.thebalance.com/credit-card-default-and-penalty-rates-explained-960643(3) https://www.nerdwallet.com/blog/finance/credit-score-employer-checking/(4) https://www.bankrate.com/home-equity.aspx

Related: Why Investors Should Pay for Advice