Monday, June 13, 2011

Lines of Credit Undermine Personal Finance

David Chilton, author of The Wealthy Barber, says that “The worst thing that’s happening to Canadians in the last 20 years has been lines of credit.” I think the reason for this is more than just the temptation of available credit.

Chilton popularized the idea of paying yourself first by saving 10% off the top each time you get paid. A big problem with lines of credit is that it undermines your ability to know whether you’re truly saving any money. Moving $500 into your RRSP may not help much if you also borrow another $1000 on your line of credit.

Back when Chilton wrote The Wealthy Barber, the world was a different place. People who saved 10% of their pay and managed to pay their mortgage and any other fixed-payment debts could have some confidence that they were making progress in their personal finances. But today, with a varying debt in a line of credit, it isn’t obvious whether we’re making progress. Over time we can see if we’re falling behind, but we don’t have the immediacy of running out of money before the next pay day to help us curb our spending.

It’s true that many people simply can’t resist the temptation of dipping into lines of credit, but even for those of us who try to do the right thing financially, lines of credit undermine our ability to determine in a given month whether we’ve made progress or have fallen further behind.


  1. I agree both you and David.

    Another good comment he had was about home renovations and that people get one room done and then the rest of the house looks bad, so they have to keep renovating - all financed by their line of credit. :)

  2. @Mike: I think creeping renovation is an example of people being unable to resist the temptation of easy credit. The ones I have more compassion for are those who actually try to manage their money well (possibly by saving 10% of income) but fail because they don't realize that their line of credit is growing faster than their savings.

  3. The Wealthy Barber was a revelation to me in my early 30s and I love Chilton's take on personal finance then and now.

    I find it hard to believe that folks don't realize they're falling behind in such scenarios - ie they're saving 10% but increasing their line of credit by a greater percentage.

    It's basic math. And math is not a subject that I'm particularly good at.

    My compassion really goes out to those who are stuck in dead-end jobs, have medical commitments and/or life problems that have sucked up their capital and they can't make ends meet anywhere without dipping into a line of credit - knowingly increasing their debt load because of stuff life has thrown at them.

  4. @Steve: I agree with you that people who can't get good jobs have big troubles. However, on the subject of falling behind, it's not about whether it's possible to calculate whether you've had a good month or not. It's about whether the stark reminder of a dwindling bank account is there to stop you at a weak moment. Taking weight as an analogy, it's not hard to calculate energy usage from daily activites, and it's not hard to calculate energy content of food consumed, and yet people get fat. Their problems have nothing to do with math; they need to find strength at weak moments when they're about to eat unhealthy food or skip exercise.

  5. Well said.

    I can feel this first hand. While we're saving for our future, slowly making some great gains I think, we needed to take out an LOC for our roof renovation this year and we're trying to aggressively pay it back in the next 12 months.

    Easy credit is just that, easy. There is nothing easy about paying it all back without some discipline.