Flap, Flap little Butterfly

Michael Franks |

Most people are familiar with the concept of the ‘Butterfly Effect.’ It’s the belief that a butterfly flapping its wings in one part of the world can lead to a tsunami in another corner of the world.   One small act can start in motion a chain of events leading to outcomes with enormous consequences. Like the ‘Butterfly Effect,’ there are things you are doing today that could have a lasting effect on your finances.

Credit card Debt
Using your credit cards as a way to buy things you can’t currently afford can saddle you with debt it will take years to erase.  According to a report published by the Institute for College Access & Success last December, the average college graduate leaves school with $29,400 in college debt.  Alarmingly, students are the also leaving with another $3,000 in credit card debt. Credit card debt could put you in a spot where you are paying for dinners or drinks that were long ago digested or paying off clothes that are no longer in fashion.

Take a moment to think before whipping out the plastic. Is this item something I absolutely can’t do without? Is this something I can pay off when my next bill comes due? With interest rates often in the high teens or higher, credit card debt can quickly spiral out.  Just making the minimum payments, which should at least be done to maintain your credit rating (more on that below), can still lead to trouble.

Let’s assume you just attended a college friend’s wedding out of town. That has exhausted your monthly fun cash flow, but a bunch of your friends are going to a concert you can’t miss.  You charge the ticket and go out for dinner before and some drinks after. You buy a concert tee to remember it all and end the evening with extra $250 on your credit card.  Using a calculator in the research tab on the Front Porch Financial website www.frontporchfinancial.com and assuming an 18% interest rate and a monthly minimum payment of $10 your night out would take 2.7 years to pay off and ending costing another $66 in interest.

Most credit card companies charge interest immediately on new purchases if you are carrying an outstanding balance.  So items you normally charge for convenience sake and pay off each month begin incurring an 18% interest rate. If you go to the credit card well again two months later for another assumed “must have” item and you stack that cost onto the current balance, you begin to see how you can head down a long, dark path. The extra money that goes toward credit card charges and interest is money that isn’t being used to build an emergency fund, a down payment for your first home, or a ROTH or 401k account.

Credit Score
We assumed above that you were making the minimum payments and not incurring late payment charges and penalties. Missing payments will not only incur a charge but will often cause your interest rate to increase. On top of that, missed payments can hurt your credit score.  Your credit score is a number on your credit report that projects how likely you are to pay back your debts. The scores range from 300 to 850. 720 and above is generally considered to be a “good credit”.  Three credit agencies - Equifax, TransUnion, and Experian - calculate your score based on your history of payments, debt outstanding, length of history, mix of debt and inquiries into your credit.  History of payments is one area you have control over and it is one of the biggest weightings on your credit score.  Each missed or late payment counts against you.

A low credit score can cost you money. Assuming you even qualify for a loan the bank sees you as a greater risk. To compensate for that risk they will charge you a higher interest rate.  When applying for a car loan or your first home this higher rate can end up costing you hundreds if not thousands of dollars over the life of the loan.  Employers can also look at job candidate’s credit report.  In a competitive job market a low credit score could be what separates two otherwise equal candidates.  This potential lost income could delay your ability to save for both near term goals and retirement.

Retirement Savings
All the money that goes to pay credit card interest and higher interest rates charged for having poor credit can have a major impact on your retirement savings.  These wasted costs can make it difficult to have the funds available to start your retirement savings.

The time to start saving for retirement is NOW.   A lot has been written about the benefits of saving early. Compound interest is a powerful force. The more years you allow yourself to benefit from this force the better the chance your have of meeting your retirement goals.

A 22 year-old that saves $2400 a year at 7% compound interest ends up with $638,690 at age 65.  If that 22 year can’t afford to save until they are 30 years old the same $2400 a year at 7% only ends up being $384,809. *

Failing to be in a position to participate in your companies 401k can cost you in another way.  If your company offers a 401k match and you are not taking advantage of that you are giving away free money.

The small acts and decisions you make today can have a long lasting impact on your financial life. Think about the long term and flap, flap little butterfly!