Learning finance

How Credit Card Debt Can Help the Poor

It’s time for Americans to learn to save. Last year, we saved an average of 4.5% of household income, about half the historical rate, and most of it was concentrated among the wealthiest households. It is therefore understandable that a number of groups focus on teaching the poor to save money. But a growing number of them recognize that to enter the mainstream of the economy, people also need good credit. (Even the post office has explored the possibility of modest banking and lending services for customers.) That can be a tough sell. “We fight against the feeling that you should cut up all your credit cards,” says Ricki Granetz Lowitz, director of the Local Initiatives Support Corporation.

Yet saving and borrowing responsibly, Lowitz realized, amounts to the same thing: setting aside small amounts to achieve a goal. So she took the type of twinned savings account that is used to encourage low-income people to save and modified it into something called Twin Accounts – the type of loan Shavers received – which generates both savings and credit. “I thought people who were poor paid more for everything, and that’s absolutely not true,” she says. “These are people with bad credit.” Eugene Reese, a 38-year-old confectionery worker who just paid off his Twin Accounts loan, remembers trying to buy a Cadillac for $6,500. Another customer had $500 and a credit score over 700. Reese had $2,800, but no credit. The other guy took the car. “It made me realize that I saved some money — might as well keep it under your pillow,” Reese says, “because it doesn’t really matter anymore.”

From a behavioral economics perspective, borrowing may actually be easier than saving, and not just because it provides instant gratification. While a wish to save $100 a month can quickly go down well with many plans, owing someone else $100 a month is a powerful motivator. Jonathan Morduch, a New York University economist who studies the consumption habits of low-income families, tells the story of Khadeja, a Bangladeshi woman who borrowed money at 36% interest to invest in gold jewelry. She knew she would probably never be able to save enough to get it, but she would make sure to make her payments to the lender. “Khadeja saw the truth of a strange paradox,” Morduch and his co-authors wrote in “Portfolios of the Poor: How the World’s Poor Live on $2 a Day.” “If you are poor, borrowing may be the fastest way to save.”

Khadeja may have paid more to borrow, but she was also buying a service — obligated to pay. Most of us already use this service constantly, managing our money by borrowing and saving at the same time. In 2000, two business school professors found that 90% of Americans with credit card debt also had cash, and about a third of them had enough to pay off all the debt. But they didn’t. One reason is that if you spend your savings, you quickly go back to zero. So you may prefer to pay a little more to borrow while keeping something in reserve. “We use credit cards all the time, so why can’t other people borrow when needed?” Morduch said. “They have the same needs. The impulse not to help people access credit is based on good intentions, but it is not based on an understanding of how people live their lives responsibly.