Should I pay off my credit cards? -- Wealth Builders Basics

Wealth Builders through all of time have utilized debt to their great advantage and benefit in setting up new businesses, creating enterprises, expanding their empire of assets and so forth. But associated with debt is what is often called "the cost of capital" - that is, what interest or other forms of payment are you making in exchange for the use of that capital? And it is the answer to that question that should dictate an answer to the basic question "Should I pay off my credit cards?".

Credit cards, as you are well aware, offer unsecured debts - that is debt that is not bound to any of your assets or income. The credit card company has little recourse to recover their money except through collection agencies and court proceedings. The former are not always effective and the latter gets expensive. Their fundamental threat is to ruin your credit history which will then raise the cost of future borrowing for you. Because of this inherent risk, credit card companies tend to limit the amount you can borrow and slap on a high interest rate on their cards. This rate can run in the 10-25% range. Compare that with mortgage debt, where your house is effectively "owned" by the lender - and thus you can get access to the capital at a low 6-7% rate. Car loans tend to be a tad higher than home loans because the value of a car depreciates quickly, and the banker does not wish to be left holding onto a low-value car if the buyer defaults.

Having said that, credit card debt does have one advantage - and that is, you are free to choose how to use that money. Unlike car loans and home loans where the deployment of the capital is pre-determined, credit card debt is like having cash (though at a high cost). Some entrepreneurs have begun their small businesses entirely on money from credit cards. However, owing to the high cost of capital (10-25%), it puts the onus on you to generate returns that exceed that cost of capital - that is, whatever enterprise or asset you deploy that credit card loan into, must generate rates of return in the 30% range (net profits before interest) for you to come out ahead. This is a tall order for most start-ups, which generally lose money in their first 2-3 years of operation.

The worst situation that any wealth builder must immediately avoid and take a solemn oath to never do is to take the credit card debt and use it to buy items that go down in value over time - example clothes, books and so on. This is acceptable only in the extreme circumstance where you are just starting off a new job and need some clothes and shoes to help do your job well. Otherwise, stay away from this form of consumer debt - and if you have any, then, without a moment's hesitation, pour money into your credit card debts and pay them off pronto!

As a general rule of thumb, there are almost always better avenues for getting access to capital that you need than credit cards. Retain them for emergency purposes, and even then, attempt to use the capital wisely. Understanding the cost associated with that capital, and the flexibility afforded, will always help you gauge the best use of credit card loans, if you ever need them, in your situation.