With President Obama signing the credit card reform bill into law, the pile of credit card debt sitting on your balance sheet might not seem so bad and could possibly be getting better. But is that true?
To find out, we first have to understand what debt really is – leverage. Yes, debt is leverage, nothing more, nothing less. It simply magnifies the gains or losses on assets purchased with the borrowed money.

Let's use housing as an example. If you buy a $500,000 house with 20% down payment ($100,000), you have to borrow $400,000. You are using four parts borrowed money and one part your own money, resulting in four-to-one leverage. If the price of the house goes up 10% to $550,000, the gain to you is $50,000, which is 50% of your initial investment. In other words, on a 10% increase in the price of the house, you made a 50% profit.

What this means is whoever loaned you the money isn't going to gain if the house goes up in value. All you have to do is pay them back the amount promised. You get any gains all to yourself. However, this works in reverse as well. The lender doesn't share in the gain, but they don't take the losses either (unless there's a foreclosure – a subject for another time).

If the house goes down 10% to $450,000, the loss to you is $50,000, which is also 50% of your initial investment and a 50% loss to you. Just as before, the debt when the value changes acts as leverage to magnify your position, in this case for big loss. (To learn more about real estate in a recession, check out Buying A House In A Down Market)

It's easy to see how people got into trouble in the housing marketing collapse with zero down loans. Any fall in price put them underwater in a big way since they absorbed 100% of it. With no cushion from a down payment and increasing interest rates from adjustable loans, it's no wonder there's so many foreclosures.

But housing historically trends upward and homes are typically appreciating assets, which is why leverage in buying a home is so often effective.

Credit cards, on the other hand, are used to buy depreciating assets, things that fall in value or just get thrown away once used. So using debt to make these purchases leverages their cost, sometimes considerably. This is why credit cards, even if interest rates were reasonable, would still be a bad idea. In general, borrow only for appreciating assets and avoid borrowing for depreciating assets. Your balance sheet will be glad you did.

So despite the legislation, which will help consumers a bit and we all should be thankful for that, the answer is that credit card debt will continue to stink. Unfortunately, all that credit card debt sitting on you balance sheet is still just a big pile.

Learn more about managing that pile of debt by reading our Expert Tips For Cutting Credit Card Debt.

Related Articles
  1. Investing

    What’s Holding Back the U.S. Consumer

    Even as job growth has surged and gasoline prices have plunged, U.S. consumers are proving slow to respond and repair their overextended balance sheets.
  2. Credit & Loans

    What's a Nonperforming Loan?

    A nonperforming loan is any borrowed sum where the borrower has failed to pay scheduled payments for at least 90 days.
  3. Savings

    How Volatile Exchange Rates Affect Your Vacation

    Those ever-changing fluctuations can make a difference in anything from your hotel room to an ATM transaction.
  4. Credit & Loans

    Can Corporate Credit Cards Affect Your Credit?

    Corporate cards have a hidden downside. If the company fails to pay its bills, you could be liable for the amount and end up with a damaged credit rating.
  5. Investing News

    What Is The New Credit Card Chip Good For?

    Under current U.S. credit card requirements, credit card issuers are required to issue chip cards as of October 1, 2015. Instead of swiping your card as you do now, you will slide the card into ...
  6. Credit & Loans

    5 Ways to Maximize Your Credit Card Points

    How to get the most bang for your rewards buck.
  7. Stock Analysis

    How Rollins Inc. Transformed from Radio to Pest Control

    Discover how Rollins, Inc. grew and expanded, making numerous acquisitions, transitioning from the radio industry to the pest control industry.
  8. Investing

    How to Effectively Compare Credit Card Rewards

    There are so many different reward credit cards that are available. Understanding how each type work will help you pick the best card for your needs.
  9. Credit & Loans

    Your Credit Score: More Important Than You Know

    Credit scores affect key aspects of your personal and professional life. Knowing your score and managing your credit input can make a big difference.
  10. Credit & Loans

    Joint Credit Cards: The Pros and Cons

    A joint credit card may sound like an easy way to split the bills, but make sure you know what you’re getting into first.
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Debt/Equity Ratio

    1. A debt ratio used to measure a company's financial leverage. ...
  3. Transferable Points Programs

    With transferable points programs, customers earn points by using ...
  4. Luhn Algorithm

    An algorithm used to validate a credit card number.
  5. Personal Property Securities Register ...

    A written, public, online record of legal claims to personal ...
  6. Roll Rate

    The percentage of credit card users who become increasingly delinquent ...
  1. How can I take a loan from my 401(k)?

    The majority of employers offer eligible employees the opportunity to save for retirement in a qualified plan through paycheck ... Read Full Answer >>
  2. What does a futures contract cost?

    The value of a futures contract is derived from the cash value of the underlying asset. While a futures contract may have ... Read Full Answer >>
  3. Are there leveraged ETFs that follow the retail sector?

    There are many exchange-traded funds (ETFs) that track the retail sector or elements of the retail sector, and some of those ... Read Full Answer >>
  4. What are some common cash-debt strategies that occur during a spinoff?

    Cash-debt strategies that are commonly used to in a spinoff to enable the parent company to monetize the spinoff are debt/equity ... Read Full Answer >>
  5. What are the similarities and differences between the savings and loan (S&L) crisis ...

    The savings and loan crisis and the subprime mortgage crisis both began with banks creating new profit centers following ... Read Full Answer >>
  6. What is the difference between "closed end credit" and a "line of credit?"

    Depending on the need, an individual or business may take out a form of credit that is either open- or closed-ended. While ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!