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If you’re familiar at all with the works of British sci-fi author Terry Pratchett, or if you read a lot about economic theory, you’re likely to come up with what is termed the “Sam Vimes Theory of Socioeconomic Unfairness.” Specifically, it’s the Boots Problem, as follows:
- Sam Vimes earns only $38 a month. A good pair of leather boots costs $50 and lasts a lifetime.
- A cheap pair of cardboard boots costs $10 and wears out in two years.
- Sam Vines cannot afford a pair of $50 boots. However, in 10 years he will have spent $100 on cheap boots and will continue to spend more, while a richer man will have saved money by only buying a pair of $50 boots once.
- Thus, to quote Pratchett: “The reason that the rich were so rich, Vimes reasoned, was because they managed to spend less money.”
It’s useful to apply the Vimes Theory when considering whether to purchase something on credit. After all, even if we attempt to avoid consumer debt, we still understand the value of taking out loans for college degrees or cars, and we’re perfectly willing to pay a little extra for important expenses like life insurance. So what if Sam Vimes had a credit card and the option to purchase his $50 boots at 17.91 percent interest?
Would it be a wise decision?
There are a number of individual factors that affect this equation, but let’s do the math. Let’s assume two things:
- The $10 that Sam can pay right now, in cash, is a $10 he has every month to pay towards his credit card debt.
- All of Sam’s other income/expense factors remain constant.
According to Bankrate’s credit card calculator, at 17.91 percent interest, Sam will pay off his good boots in only five months. It seems like a fair deal, especially compared to buying new, cheap boots every two years.
Let’s see what happens if the numbers get bigger. Let’s say Sam wanted to invest $5,000 into adding solar panels to his roof. This’ll save him in energy costs down the line, plus it’ll be good for the environment. And let’s say he can pay back $100 every month. (Real solar panels cost closer to $50,000 than $5,000, but I’m keeping the math simple.)
In this case, it’ll take Sam seven years and nine months to pay down that debt, at 17.91 percent interest. Sam will also pay $9,200 against the $5,000 debt, nearly double what those solar panels originally cost. On the other hand, the average solar-paneled roof cuts energy costs by at least 50 percent, meaning after seven years Sam could be making back some of that additional money. People who install solar panels also often get tax credits, and they raise the value of their home and property.
The fact is that consumer debt, whether it’s in the form of a credit card charge or a bank loan, isn’t necessarily all bad. Remember that sometimes paying with cash costs you more — in the Boots Problem, cash costs just as much as credit, and you still only end up with cheap boots.
What does this mean for you? It means that you should look at expenses judiciously. It doesn’t make any sense to ring up your daily latte or Pret a Manger lunch on a credit card if you aren’t earning enough to pay the balance, but it does make sense to buy some items on credit if the overall amortized cost of purchasing a high-quality item now is less than the anticipated interest charges. (This does require you to look at your purchases realistically and decide in advance how much of your debt you’ll be able to pay back every month; magical thinking, or assuming it will all work out, does not apply here.)
If you need to put your boots on credit to continue paying other expenses, such as your car insurance, life insurance, and health care premiums, that’s okay too. It’s also a good idea to make sure you’re paying as little for your required expenses as possible, so search comparison sites like BestLifeQuote.com at least every six months to make sure you are getting the best deals, especially if you need high risk insurance.
Am I in favor of using credit without thinking about it first? Absolutely not. But credit is a tool, and if you seriously consider the reoccuring costs of cheap boots, a junked-out car, a leaky roof, etc. against the one-time cost of fixing the problem, sometimes credit —even with interest — saves you money in the long run.
Just do the math before you buy your next pair of boots, okay?