They're everywhere. You've probably seen them a thousand times in newspaper ads and on television commercials. Looking at them, you'd think that the entire business world has gone a bit loony, trying to give away their products to anyone who wants them. They make you think that you can have whatever your heart desires, no matter what your financial situation happens to be.
They're credit offers, and they take many forms.
Looking for a house but don't have a million in the bank? Get an adjustable rate mortgage from our company and pay just 1.99% for the first year. Need a new car? Prove to us that you have a job, any job, and that plus a crisp dollar bill will let you drive something off the lot today. Want to buy enough furniture to fill the house you've always wanted? Go ahead and take it off our hands; don't pay a cent until next year. Don't you deserve the vacation you've always wanted? Take this credit card advance check and get a great rate during our special introductory period.
Living in the moment
Offers like these appeal to your sense of immediacy and entitlement. It's extremely tempting to forget about future consequences and just focus on what you can do now. Somewhere in the back of your mind, you might realize that there's no way that you can possibly afford so much of what you want. Yet when you look at these offers, everything seems within reach. You can afford it -- at least for the moment. Why shouldn't you have what you want?
Businesses, on the other hand, take the longer view. They know that if they can just convince you to make the initial purchase decision, they'll get paid off in the long run. Since the main challenge is getting you to take products off their hands in the first place, many businesses are willing to forego any immediate income at all; in many cases, waiting for a few months or offering attractive financing terms represents just a small part of their profit margins.
While it's easy to lay blame for rampant debt levels on business, it's not realistic to expect businesses to protect you from yourself. Whether it's a loan officer at US Bank
When the moment ends
The problem for consumers, of course, is that eventually, the day of reckoning comes. The 1.99% introductory rate on your interest-only adjustable rate mortgage kicks up to 6% or 7%, and you suddenly find yourself with monthly payments that are three times what they used to be. As you step out of your brand-new car after work and pick up your mail, you notice that your first bill not only has a higher monthly payment than you expected but also a big one-time finance payment that you never really understood when they were rushing you through all those forms. When next year comes, you discover that your furniture retailer actually wants to get paid back for the thousands of dollars in merchandise you bought on a whim last year. And that credit card? It looks like now that the introductory period is over, they want 23% interest on that $8,000 check you wrote. Ouch.
Learn from accountants
The solution to letting your financial obligations get out of hand is to stop living for the moment and to start immediately considering all of the ramifications of your financial decisions. For help with this, you can take some guidance from the world of accounting.
In general, there are two ways that businesses can account for their income and expenses. In the simplest terms, the cash method basically looks only at actual money that you pay or receive. So if you do a bunch of work for someone but they haven't paid you for that work yet, you don't get credit for that income until your client pays your bill. On the other hand, you also don't have to count things like utility bills or license fees until you actually write a check and pay them.
The advantage of the cash method is its simplicity. However, it can be extremely misleading for businesses that tend to have a significant lag between the time they do work or incur expenses and the time they receive payment or pay their bills.
In order to reflect unpaid income and expenses, many businesses use an alternative called the accrual method. This method doesn't focus on cash transactions. Instead, it looks at whatever action gives rise to a particular type of income or expense. For instance, if you do work for someone, the accrual method recognizes income when you've completed the work, regardless of when your client pays you. Similarly, ongoing expenses are counted as expenses as they accumulate rather than whenever you pay them.
Accrue your personal expenses
You can use the accrual method to monitor your own personal spending. If you consider not only the immediate expense but also the future costs of buying something, you'll think twice before giving in to the temptation of easy credit terms. For example, if you calculate what your monthly mortgage or car payments are likely to be after a temporarily low rate rises or a no-payment period ends, you might decide you need to spend less in the first place, preventing a money crunch later. If you can't afford thousands of dollars for furniture or a vacation now, you may realize that you probably won't be able to afford that much later when the bills come due and make a more prudent decision.
All this isn't to say that credit is inherently bad in itself. As a tool, credit can be extremely valuable. However, to use credit well, you have to be able to repay it on favorable terms that don't cause problems later. Only by considering the long-term effects of your financial decisions will you be able to assess whether you can really afford to buy what you want.
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Fool contributor Dan Caplinger treats debt like the plague but likes earning air miles on his credit card. He doesn't own shares of any of the companies or funds mentioned in this article. The Fool's disclosure policy always accrues in your favor.