Tuesday, May 12, 2009

Credit defined

We're all about the metaphors and similes here at Loonies And Sense. A few months back, I posted about another blog that had described easy credit as a bottomless cookie jar. Well, a recent post at Consumerism Commentary once again has me all revved up with a "new" way of thinking about credit.

Smithee's post on credit cards that already follow the rules laid out in the new Credit Cardholder's Bill Of Rights in the US discusses the practice of double-cycle billing:
Avoid double-cycle billing (imagine paying your rent for May based on how many days you lived there in May and April)
Maybe this is grounds for me to turn in my PF-blogging credentials, but the concept of credit as renting money really hit me when I read this. Interest is the rent that you pay for the use of the money, and heaven help you if you don't return the money in good condition when you're done with it.

This is an incredibly simple concept, and it strikes me how differently people tend to think about debt than about other items they might rent. Nobody would refer to a rented DVD, a rental car, or a rented apartment as their own property, but try to convince someone that the new car they just financed isn't strictly their own property, and you've got an uphill battle ahead of you.

This concept of renting money also underscores the difference between "good" and "bad" debt: just as we derive utility from the tangible things we rent, we can derive utility from the money we rent. With leveraged investing, it's possible (though by no means guaranteed) that you will earn enough money to pay the interest and repay the borrowed amount. Of course, we can also use this rented money to dig ourselves into a hole. If you spend the money on something that you are not able to convert back into money (i.e. depreciating assets, consumables, etc.), then you no longer have the money to return to the lender. Kind of like handing the keys of a rented apartment to a complete stranger: it makes it kind of tricky to get out of your lease.

It's hardly groundbreaking insight, but it's a new way for me to think of credit and debt, and I found it really interesting.

1 comment:

R.C.E. said...

The concept of "renting money" is much more than a metaphor. Think about the four factors of production: Land, Labor, Capital and Entrepreneurship. Each factor has it's commensurate reward, i.e. land and rent, labor and wages, capital and interest, entrepreneurship and profit. That thing we call "money" takes on many forms, but they all boil down to the same thing.