An excellent metaphor for credit

For a while now, I've been a fan of the show 'Til Debt Do Us Part. It's a highly addictive reality show about couples trying to right their financial ship and salvage their relationship in the face of out-of-control spending and spiraling debt. The host, Gail Vaz-Oxlade, is a very entertaining, no-nonsense personality, who also maintains a great blog with tips, tricks and diatribes on all things financial. Scanning through her articles this morning, I found a fantastic post likening the age of easy credit to having a bottomless cookie jar:

The problem with the bottomless cookie jar is that eventually you begin to take the cookies for granted. It’s human nature. And so when a couple of weeks passed and none of the cookies had been eaten, I stopped filling the jar. Several weeks later, after the jar had been emptied, washed and put back in place, Alex dipped her fingers into the jar to find it empty. She was very disappointed. The cookies were gone. It was the end of the world.

This serves as a very effective metaphor for people's relationship with their credit. Just look at the mystery surrounding the calculation of credit scores and credit limit assignment criteria, and it's not hard to see why most of us don't really understand how we got the credit we have. When a bank first hands you a $10,000 credit line, it's difficult to imagine how you could ever spend that much money, and you can develop a false sense of your ability to manage the ensuing debt. "They wouldn't have given me the limit if I couldn't handle it!"

I remember when I first started digging my way into my hole of consumer debt, I looked into the option of getting a line of credit to pay off my credit cards. At the time, my utilization was so high that I didn't qualify (thankfully), and I spent a good deal of time thinking over how to approach the problem of my debt. I'm a smart person, but I found myself grappling with the idea of whether consolidating my cards onto a line of credit would solve the problem. A small voice in the back of my mind tried to explain that shuffling and adding to the pile wouldn't get me anywhere, but I still didn't get it.

I find this disconnect fascinating. The "math" of personal finance really couldn't be simpler: you need to earn more than you spend, and you need to pay off more than you add to your debts. There's not even any multiplication or division here; it's straight addition and subtraction. Heck, you can even reduce it to the point of "is this number bigger than that number?" All the same, however, we all seem to struggle at some point with this dilemma. We just don't understand how the cookie jar works.

Financial Archaeology: Unearthing Past Behaviour

I've been looking through my historical bank balances online, and I've noticed some interesting trends. I've already written about the trends in my overall net worth, but I thought I'd go a little deeper into the details for individual accounts. Whereas my net worth growth indicates whether I'm getting "richer", these finer details should be more indicative of changes in behaviour.

I'm a paper packrat, so I have years' worth of paper statements stockpiled at home. Over time, I'd like to go through old credit card statements to get an idea of where and how I spent my money before and after April 30, 2007 (this date is significant because it represents my first comprehensive balance sheet, and the date when I decided I had to right my financial wrongs). My online account history only goes back to the beginning of November 2006, but this is enough to get us started.

The metrics

In this analysis, I'll be looking at three metrics:

• Monthly credit card statement balance - Since I use my credit card for most of my monthly spending, my monthly statement is an excellent indication of how much I've spent in a given month. This will basically represent my monthly cash outflow.


• Month-end line of credit balance - I use my line of credit to pay off my credit cards every month. Before you bristle at this statement, and tell me that I'm not "paying off" anything at all, merely moving debt around, remember that I make a corresponding payment to my LOC for every purchase I make with my credit card. For example, if I spend $40 at the supermarket using my credit card, I come home and transfer $40 from my chequing account into my LOC. Because I manage my cash flow this way, my LOC balance represents the amount of "old" debt I'm still carrying around. As I dig myself out of debt, this number should go down.


• Monthly line of credit interest - As my LOC gets paid off, the amount of interest I'm charged each month will also go down. There's an added wrinkle here in that I've got the lion's share of my "LOC" debt sitting on a 0% credit card, but this really just means that more of my monthly LOC payments actually goes toward principal. My monthly LOC interest represents the amount that my "old" debt is costing me each month.

With these three metrics in mind, let's have a look at the history I have available. I currently have data from November 2006 through March 2008, so I really have two options:

• Compare the Apr'07-Mar'08 numbers to the Nov'06-Oct'07 numbers - This will provide me with two "year-in-review" summaries that I can compare to each other. The concern here is that I have substantial overlap between the two periods being compared (Apr'07-Oct'07), so I'm not comparing distinct time periods.


• Compare the Nov'07-Mar'08 numbers to the Nov'06-Mar'07 numbers - This gives me two distinct time periods to compare, but I'm not looking at a full 12 months' history.

I prefer the second option, since it gives me a "clean" comparison of this year vs. last year, even if it's not a full 12-month picture.

The numbers

Now let's see how the three metrics stack up year-over-year.

Credit card spending

From November 2006 through March 2007, I spent $19,229.60 on my credit cards. As I type that number, I get a bit of a queasy feeling in my stomach. That's an average of $3,845.92 per month in credit card purchases, sustained over a 5-month period. I wish I could at least attribute this to one event skewing the results, like Christmas gifts or major car repairs, but the lowest monthly spending I had during this period was $2,818 in January, so this was indeed a consistent trend.

Fast forward to the past few months, where my total spending from November 2007 to March 2008 came in at a mere $10,163.05, or 53% of last year's spending over the same period. Note that the numbers for both years cover the Christmas shopping season, so this represents a huge change in behaviour.

Whatever challenges I may still have with sticking to a budget, my habits have clearly changed a lot from a year ago.

Line of credit balance

Throughout most of 2006, my LOC balance had held reasonably steady, in the low teens. Then, from November 2006 through March 2007, the balance started a period of rapid growth, going from $12,446.82 to $18,260.50, an increase of $5,813.68, or 47%. Comparing this number to my $19,229.60 in credit card spending during the same period, I'm actually amazed that this balance increase wasn't a lot higher.

Looking at the same period this year, my LOC balance dropped from $21,040.90 to $20,044.16, a reduction of $996.74, or 5%. That's another huge improvement.

Line of credit interest

Finally, let's look at how much my revolving debt has actually been costing me. Every dollar that I pay in interest on my LOC is a dollar subtracted from my debt payments, so minimizing this number is important in paying off the debt as soon as possible.

From November 2006 to March 2007, I paid $425.24 in interest on my LOC. Compare this with the $366.68 that I paid during the same period this year, and I'm making good headway. With more of my payments going toward principal, my debt reduction will move a lot more quickly.

Conclusion

There are really three conclusions to be drawn from this dig into my recent financial past. Strangely enough, this works out to be one conclusion per metric:

• My credit card spending (and therefore my general spending) is dramatically reduced from this time a year ago. Forcing myself to spend less than I earn has really paid off. Even though I'm still using my credit card for the vast majority of purchases (as well as some utility bills), my current spending is just over half as high as it was last year. No matter how you slice it, that is a major step in the right direction.


• My LOC is being steadily paid off. The beginning of 2007 was really the time when the balance started to skyrocket, and I've managed to reverse that trend, and actually bring the balance down. This is due to a consistent focus on debt reduction, combined with some basic saving for the unexpected (as well as the expected). Balances are moving consistently in the right direction, which is a great motivation to keep things that way.


• I'm paying far less in interest on my revolving debt. This is largely due to moving the bulk of my debt to a 0% card, but regardless of the reason, it means that the majority of my debt payments are going directly toward principal. By taking steps to slow my interest accrual, I've really accelerated my debt paydown.

As I unearth more history over the next little while, I'll try to dive a little more deeply into the credit card spending in particular, but this quick analysis of my recent past has really opened my eyes to some significant behavioural changes that I've made.

If I don't roll up the rim, who will?!

This afternoon, I had a moment of weakness, and went down to the Tim Hortons in the food court to get a half-coffee/half-hot chocolate (a café mocha without the whipped cream). Much to my surprise, I was handed a Roll Up The Rim To Win cup. It turns out, this year's iteration of the annual promotion/sweepstakes has been running for over a week.

A year ago, I would have known about this within hours, not days. I guess I really have changed some habits in the past year. Without really noticing myself doing it, I've ditched my daily Tim Hortons habit, and turned their coffee into a once-in-a-while treat.

For those of you who just can't get enough of rolling those R's, you can track one blogger's adventures at this new website.

I haven't finished my coffee yet, but I'll let you know if I win the Bayliner bowrider or the Toyota Matrix.

Happy rrrolling...

I've come a long way

I just got back from taking a late lunch break. Today, for lunch, I decided to head down to the food court. All this recent talk about McDonald's double cheeseburgers seems to have gotten to me, so I treated myself to one of these burgers ($1.47 with tax) and a Tim Hortons coffee ($1.43 with tax).

As I sat enjoying my heavily processed guilty pleasure ($2.90 total), I suddenly realized just how rarely I actually buy my lunch these days. Six months ago, I was buying my breakfast virtually every morning, and eating lunch in the food court at least twice a week. Fast-forward to today: I eat breakfast at home and brown-bag my lunch almost every day, and every morning, I walk into work with a travel mug of home-brewed coffee. I hadn't even really noticed that I had broken my old habit, let alone building this new, improved one.

Sad to say, it doesn't look like my new breakfast and lunch habit will let me retire at 35, but the important thing is that I do not miss the old habit. Preparing a lunch (anything from leftover pasta to a simple PB&J sandwich) at home has simply become part of my routine, and pouring myself a coffee before leaving for work is one of the little pleasures of my morning. True, I'm sometimes tempted by fast food options on the way to and from work, but the feeling of positive change I get is far more significant than any "sacrifices" I may be making.

Until now, I didn't realize just what creatures are habit we really are. Well, I believe it now, and you can be sure that I'll be looking for ways to use this concept in the months ahead.