Spending Habits That Defy Logic

As I have alluded to it briefly before, we are in for some steep medical bills with limited insurance coverage. We are still working out exactly what and how much insurance will cover, but when the dust settles, I think our out-of-pocket expenses over the next couple of months will be in the range of $7,000 - $12,000 :( We don’t know if that will be the end of it, or if the bills will continue through next year. We have seen this coming for a while now, and still our emergency savings sit at the same $5,000 - $6,000 that it has been at for the past year or so. I don’t know if we have been living with our head buried in the sand hoping that somehow, magically, we can dodge the bullet, or it is just a matter of old habits dying hard.

During our days in college when we were out on our own for the first time, we got into the habit of charging everything to a credit card. It led us to a lot of financial trouble that took a lot of time to clean up. We have learnt and incorporated a few important lessons ever since such as living within our means, saving up for retirement, investing some money and aggressively paying off the mortgage. But one thing that has not changed is our spending habits. For some reason we still rely heavily on the use of credit/loan to pay any big ticket items or bills. Somehow, even though we have been fairly diligent in saving money, we always use up all the savings to aggressively pay off some older debt (mostly mortgage, and in recent months, auto loan) or invest it. We have never really been the ones to save up for a big purchase/bill even when we see it coming. Our attitude has always been to use low-interest loans for any major purchases/bills and then try to pay it off aggressively later.

If you look around the personal finance blog world, you will probably notice that most people fall in one of the two categories – those that always save up for purchases ahead of time or those that almost always leverage available credit. People in the first category are careful about their spending habits, have at least three months of living expenses stashed away in emergency savings and are in general prepared for what life throws at them (or at least working towards that goal). People in the second category usually try to gain the most possible leverage out of available credit by obtaining low interest debt and investing it in endeavors that offer better returns. If you ask the question “Should you pre-pay your mortgage?” people in the first category will likely answer “Yes, it’s a huge debt, so get rid of it as soon as possible” and people in the second category will likely answer “No way, stretch it as much as possible since the interest is low and has so many tax benefits”.

Our spending habits seem to defy logic and not fall in either category (or falls in both categories, depending on how you see it). I dabble heavily in credit card arbitrage where I take money from 0% credit card balance transfer offers and park it in an online savings account to earn interest. For our car purchase, we chose to take out a loan instead of using our savings, since the interest rate on the loan is 5.25%, far lower than what our investments are doing. And like I mentioned above, we use credit for all major purchases/bills availing any cash back bonus on credit cards as well as any 0% offers. So that should put us in the second category. However, while we rely quite heavily on credit, we are still quite debt averse. We make additional payments to our auto loan and mortgage on a regular basis, even though investing that extra money would probably yield better earnings. Having debt really bothers us and we go out of our way to get rid of any existing debt. In that sense, we belong in the first category of personal finance bloggers who shun debt at all costs.

So far, this dichotomy has worked in a positive way. We are not worried to take out a loan, so we are not too conservative with keeping a huge stash of money in an emergency account. At the same time, we are quite debt averse, and in the event that we do take out a loan we go all out at it and try to get rid of it as soon as possible. We get some of the benefits of float where we get to keep savings in higher interest investments, instead of saving it in a low interest savings account in anticipation of the big bills. Once we do pay the big bills using credit, we hate that debt and so get all stingy and creative until we have paid off that loan.

However, ever since we got debt-free (other than mortgage) a few years back, this is the first time that we have two huge loans on our hands – the auto loan and the medical loan. There is no way our paychecks will allow us to pay off both as aggressively as we would like. At this point we are trying to figure out if it is time to scale back the mortgage pre-payment or float the new loan on 0% APR balance transfers for a long time. With the first option, we end up stretching out our mortgage-free time horizon which is an inherent part of our long term goals, but it is a less risky option. With the second option, I only lose the ~$2,000 free money I was making from credit card arbitrage which is not a big deal, but it is far riskier since one of the cardinal rules of the credit card arbitrage game is to have the money easily accessible. Also, with the second option I am worried that having a lot of debt will bug us to death! This is where our spending habits that defy logic come to haunt us – neither decision seems satisfactory :(

What category do you belong to - prefer to save up for major purchases or float it on low interest credit cards? What are your personal experiences about the ups and downs of your choice?



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6 Comments:

Stephanie said...

I've heard you talk before about taking 0% credit cards and transferring money to online savings accounts to generate extra money. How does this work, exactly? Would love if you could elaborate either in a post or email me. Thanks!

Patrick said...

I'm sorry to hear about the medical issues. I hope everything will be fine for you and your family.

As for your question, I tilt more toward the save up and pay it off, but I have floated a loan on a credit car before as well. I guess I look for the best deal at the time for my current situation.

FinanceAndFat said...

Very interesting (and very honest) assessment.

I guess I don't know which category I fall into yet. I'm still too new at getting my finances figured out. I would like to think that I am the saving for purchases and avoiding loans type of person, but I'm not there yet. I think that suits me best, but it's not how I've lived my life up to now.

I think credit card arbitrage is a cool way to make some extra money, but sometimes I think we can get 'too smart' with these financial tricks for our own good too.

ispf said...

Stephanie: The basic idea is simple - accept the balance transfer offers that come in the mail with 0% introductory APR and low transfer fees. Many of these credit card companies offer balance transfer checks and some even deposit the amount directly into your bank account. Every month you make sure you pay a little more than the minimum amount, and in the mean time, the money sits in your bank account earning interest. When the introductory period for the 0% offer ends, you either return the money or roll it over to another 0% APR card. Here is an article I wrote sometime back about the basics of credit card arbitrage game. Here is another that has a bunch of questions to determine if this game might work for you. Finally today, I posted one more with a list of things to watch out for while transferring balances. I hope that helps.

Patrick, FinanceAndFat: Based on your comments I am beginning to wonder if everyone has some kind of a dichotomy when it comes to spending habits. Maybe everyone just does what is best in that particular situation (like Patrick mentioned), but since we read only snapshots on blogs, I end up thinking other people have more clear cut decisive spending habits :)

A.J. said...

I'm a little of both. It just depends on the item. I can and do frequently save up for things I want to purchase. But the larger the price tag, the more likely I am to use credit in one form or another. It is not uncommon for me to pay off the note or credit card in just a few months though. I generally don't buy unless I have a well laid out plan to pay for it.

Stephanie said...

Thanks for all the info. I'll read through everything and see if this would be a smart idea for me to make some money!