This is a second-attempt at writing about the usefulness of debt, both financial and technical, after my first attempt fell totally flat due to COVID brain (at least that’s my hope it was just COVID brain.) If you feel you read some of this before, that’s why. One of the things I’m doing different this time is that I’m separating my discussion of household debt from technical debt.
As I wrote before, I grew up in a household that had little to no financial literacy — I learnt the basics of economics out of a Disney comics tie-in to the most prominent Italian financial newspaper. At many points we ended up needing loans just to make ends meet, and that was never a good deal.
But between a little understanding through school, and the Disney tie-in noted above, and having ran “my own company” (well, freelancing) at which point I had no option to get a loan, or credit, and had to rely on (revolving) credit card charges instead, I had to learn, literally, how to manage debt.
Now, before I start talking about it, let me clarify two important points. The first is that this is not financial advice, this is just telling my story and my personal experiences with debt. The second is that all of this is about a biased game. The more you need credit and loans to pay for things, the less likely it will be that you’ll be offered good deals. And as such any lessons you may take from my experiences you may be able to take only apply to middle class earners, rather than to those who most need to gather up every little saving they can. I’m sorry but I can only write about what I know.
To move right onto the topic, debt is roughly divided between managed debt and unmanaged debt. The former is expected, tracked and accounted for – the latter is the kind of “shit has hit the fan” kind of debt that my parents had to resort to more than a couple of times while I was growing up, and obviously the most risky one.
Managed debt is not bad, as long as you can learn to deal with it. Take for example the average Anglo-Saxon credit card (the average credit card in Italy behave very differently, so I’m going to ignore those): you can buy services and goods on a credit card and, as long as you pay your statement in full at the end of the month, it costs you nothing more than the account fees, if any. In exchange you get to delay the payment for a few weeks (sometimes nearly two months), get better buyer protection than a debit card would, and in many cases some kind of cashback or rewards program. But for this to work out positively, you need to be well aware of how much money you’re going to have on your account by the time the statement hits — a skill that, as a freelancer, I can tell you I had to develop fast. It is thus unsurprising that there are many people who, despite being the effective best audience for premium credit cards and their reward programs, prefer sticking to debit cards.
Another useful tool is the 0% installment plans from the likes of PayPal — while the offers of no-interest credit are less likely to be extended, given the current interest rate hike, it is also a good time to know how to use them, as I have definitely used them successfully in the past. The method I used is to consider the full amount of money spent the moment you start the plan, but keep it in a bank account that provides active interest on the deposit. While there aren’t that many basic bank accounts that pay interest on deposit, at the very least Santander and Fineco offer some amount of interest on their deposits, and I have found out recently that you can sign up for some level of active interest with Wise (full disclosure: I bought some Wise stock back when it IPO’d because I believe they are more sustainable than other players in the market.)
Take as an example the gaming PC I bought last year: given the current terrible market for graphic cards, the price was annoyingly high at £2000 — but still a price I would have been able to pay “cash.” But Scan Computers, who I bought it from, offered PayPal 0% Credit for 48 months, — I knew the money was already spent, so always budgeted for it as being “invisibly booked” in the bank account for the next four years, but even at that point with a 0.5% AER, it would have been a few pounds extra with basically no additional cost — with the current going rate of Santander of 2% AER (gross) it would be the equivalent of roughly £80 “cashback” just by not paying it immediately (minus taxes and so on.)
Using a tiered set of savings account with different lock-in period would significantly increase that number: a not-really-quick spreadsheet shows that, given the currently available UK saving accounts, trying (not too hard) to optimize to avoid having to move money across accounts more often than once every six months (with the exception of an easy-access account), it should be theoretically possible to come back with just over £400 gross interest at the end of the four years.
To be honest, while the sum is definitely not low, it is also the type of sum that, for people who can usually afford this game, is “too small to play” — you need to remember to close savings account at the right time to avoid fees, though if you have a steady income stream you may find yourself happily stretch the saving horizons as well. Which again shows this is not a fair game: the more you spend with offers like these in place, the more it is convenient to learn the game — those who might benefit from having an extra £100 a year in their pocket might not be able to afford putting that much cash into (so many) savings accounts.
It is also not fair because taking the 0% finance offer is a ding on your credit score: it was not a problem for me, but it might be for people who are already struggling maintaining their score high enough, or that might be looking to open a mortgage on a short time horizon. And this is without ranting on about the silliness of some of the credit score idiosyncrasies — or the fact that Experian tries to sell you a “score booster” service!
This is the paradox of (household) debt. Many people need financing offers to be able to choose the more durable, more pricey option rather than being stuck with a short-term cheap, long-term expensive option (see Boots Theory), but because of that very same reason they are not offered 0% plans at all. Those who can afford to buy outright are being given a chance to make their own money work for them again. But at the same time almost all financing options are a trap for those who use them: if you don’t set aside the cash to pay for the full loan right away, and your income is not steady throughout the period, you risk finding yourself unable to pay, and that’s going to be a difficult position to get out of, let alone the interest repayments, credit scores would not clear that out for many many years.
There is another risk, which is more psychological than anything. If you’re in a situation where you can afford a few things, and credit is still available, it is not difficult to splurge it on extravagant or frivolous expenses — I say that by personal experience. As I said before I didn’t grow up in a very financially literate family, and while I could bring up a number of different examples from my direct relatives, I will take one of mines instead. Back in the days, my mother got me used to basically door-to-door encyclopedia salesmen (how stereotypical!), to the point that twice I signed up for an installment plan from DeAgostini, once to complete my collection of Lupin 3rd DVDs, which to be honest I still think was a decent purchase, and a second time for a much more frivolous Lord of the Rings inspired chess table (solid wood, to be honest it is a thing of beauty, but definitely not something ever needed!) with not one but two chess sets with the characters from the movies. It took me years to repay those two plans — and only towards the end a bank (ironically, Santander) got involved, previously the publisher handled it directly, which is how I could “afford” it at that point.
This reminds me I should eventually get to talk a bit about the very much non-uniform experiences with door-to-door salespeople that I had to deal with in Italy, in no small part because of my mother’s habits. But that’s for another time.
Anyway, while it is definitely possible to spend quite a bit of time to optimize the repayment of a 0% debt to maximize interests, this is not something that most people would have the time or care for. To be honest, neither did I! What I ended up doing with the PC above was to take the £2000, deposit them into my ISA, and just take a mental note that our monthly available budget decreased by £50 — since my income is still steady, the full amount can stay into the savings account, aware that if we do end up in a pinch I’ll have to take it out. Nevertheless, if I have a chance to pay by installments (even with the likes of Buy-Now-Pay-Later providers such as Klarna or PayPal’s “Pay in 3”) I generally do — never pay in full, full price.
And here is where I want those still reading to pay attention: full price is the important part here. Sometimes “full price” is not a clear-cut definition as you may think. For instance, often the same good is available at different stores, but if the options are paying it at retail price on a 0% plan, and getting it for any amount of discount, cashback, or even points at a different retailer, I’m likely going to go for the latter, all things equal. In some cases, you may be eligible for some other discount or tie-in offer but only as long as you don’t pay by installments, in others you may find that the price difference between two stores, for the same exact item, is higher than the interest you would earn if you had to pay no installment at all for the credit period!
This shouldn’t surprise many people who have worked for small companies: while 0% credit is usually free for the consumer it rarely is for the merchant. Depending on volume, providing the credit option may cost more than 10% of the transaction to the merchant — but as long as it does not completely null out the profits, it’s usually easier to consider it a marketing expense: without it a lot of people would just not buy the item at all, because they don’t have that kind of cash at hand. Patrick McKenzie (as always) put it better than me. Knowledge of this is, effectively, power — at least if you have read Getting More by Stuart Diamond, and know that any transaction is a negotiation.
There is very little power in any knowledge when your negotiation happens entirely through a computer, except insofar as you can compare different stores and figure out what the best option for you is, between paying in full now (with a higher discount) or paying the full price in installments. But if you’re dealing with a small business directly, say for instance with a dentist, you may be able to make use of that knowledge: if a 0% financing option is available, offer them to pay in full for a 5% discount. It works, or at least it worked the one time I tried this.
As I said it shouldn’t have surprised me: back when I was freelancing I was offering two options to my customers: NET30 (pay in full, no later than 30 days after invoice, by bank transfer), or a 5% discount for paying the same day of the invoice via PayPal. The discount would actually cost me more than 5%, because I had to pay fees to take the payment over PayPal, but it would mean the money would hit my bank account on my own terms, rather than hope that the accounts payable of the customer would be processing the invoice as agreed (it was very rare they would — even Google’s.) And honestly, most of us who deal with subscription services should know exactly how that feels: how often do you find yourself being given the option to pay “12 months for the price of 10” (effectively a 20% “discount”!) when signing up for yearly rather than monthly billing? This is all the same.
And it is not just about buying goods or services: a few years back when me and my wife were looking for a new place, I had just left one bubble for another, and so we were househunting while I was still on probation at work. The landlord of one of the flats we were interested in (but didn’t pick in the end) had an explicit “no probation” requirement, so we could have just consider it a lost cause… except that I had been planning for one vacation and two months traveling to see families before I resigned, before the lockdowns started, and together with the sign-in bonus of the new job it meant I had an ace up my sleeve: I inquired whether it would be acceptable, given my probation, to pay the full 12 months rent in advance — with a 10% discount. As it turned out, yes, that would have been quite alright with the landlord (the flat didn’t work out for us for other reasons anyway.)
Now, I can already hear some of my acquaintances ask if there is any space for a fintech company to “exploit the arbitrage opportunity” to “extract value” from this. After all, I have shown above that there is an optimization available with different tiers of saving accounts — but I don’t think there is much to be done there. I’m just applying the very basic practices of debt markets to household debt: to maximize returns, instead of worrying about individuals’ debt, you can already turn to the wider debt markets, and pretty much fit into the same gap.
I would rather think that this type of calculations is in the space of budgeting apps, that could be able to suggest “You have £X00 booked in your account for That Installment Plan that are not due for another 12 months, consider transferring to your savings account.” This type of advice is very situational, though. As I wrote earlier, this time around I am confident enough in my short-to-medium term income that just holding the whole plan’s value into an ISA was a fairly obvious choice — back when I was a freelancer, using a savings account to try and keep the VAT due to the Government ended up costing me more than it paid off: revenue was too unstable to make regular payments, and I ended up paying more in fees to get easy access to the money.
And at the same time, all of the “budgeting” applications I have seen up to now seem to be financial data collection in disguise: either for credit reporting purposes, or from various banks to see a bigger picture of your finances across different institutions. I’m not saying that they all are predatory, but I will say that I’m glad I don’t have to figure out which one of them is trustworthy on my own data.
Anyway, here is basically all I know on this topic, but I hope I ended up with a better explanation than the one I gave before on how I got used to the idea that, after all, debt is not always a bad word — dangerous as it is.
