FrugalNoggin

Manage Credit

Credit cards can be a blessing or a curse. You can be a wise user of the “right” kind of credit cards, have a good credit rating, pay your bill in full, and not pay high credit card fees. Or you can be trapped by a “bad” credit card with high fees, a balance you can’t afford to pay off, or other terms you find objectionable. The worst part is that if you choose to ignore credit cards and not have any, you may find yourself in an even worse state, as financial institution use your credit card history to help establish your credit worthiness when applying for loans (like car loans and mortgages). You may find it hard to obtain these loans, or at least get a good rate for one, unless you establish a responsible history of credit card usage first.

Debt (the borrowing of money) can come in many different areas of our lives. Most of us will be unable to purchase a home without some type of borrowing. The purchase of a new car also usually requires some financial help. Other large ticket items might also be financed over time. In all of these cases, when we make this type of transaction, we agree to pay a portion of the price each month for a set period of months, at which point the debt is paid off. Of course the lender is paid a fee for the ability to lend us this money, known as interest. These payments are known as installments and this type of debt is known as installment debt. It can usually be characterized by a fixed payment, a relatively low interest rate, and set term. Installment debt is easily budgeted for (since the payment is fixed) and can also usually be pre-paid without penalty, thus saving future interest payments. The type of goods typically purchased using installment debt tend to be goods with long lifetimes (like houses and cars) so they generally last longer than the payment terms and are thus “good investments” of the money spent. In many cases, even if you have the cash, you can invest it in another investment that earns more than some of these installment debts cost when purchasing certain goods.

Revolving credit is extended by department stores and other non-retail lenders (banks) intending that you use your “credit line” this month, pay it, and “revolve” the borrowing amount into the following month. Any amount not paid this month is charged a finance charge, which is usually quite high when compared to the installment debt discussed previously. A typical installment loan might have an interest rate of 8-10% while a revolving credit card might have an interest rate of 18-20%. If you were to pay the minimum payment on both loans, you would pay off the installment loan in 4 years but you would not pay off the credit card until 30 years! You would pay an additional $6,000 in interest using the credit card vs an installment loan. Clearly, buying something where you can only afford the minimum payments on your credit card is a very expensive solution.

Credit cards are very useful tools, however. They can help you establish a history of wise credit management in order to qualify for low rates on other installment loans for big-ticket items that can otherwise cost lots of money. They can help you manage your cash on a daily basis by not requiring you to carry large amounts of cash. You will receive a nice, detailed statement each month with each and every item you bought and where. All you have to do is pay the bill on time and in full. If you’re the type of person who can’t resist buying something “on the card” when you see it, without consideration for how you’re going to pay for it in 30 days, take the credit cards out of your wallet right now!

Eliminate your credit card debt. Look at the areas where you spend the most using your card and reevaluate whether this is a good use of revolving credit. Purchasing items of short useful life with credit card debt is not a good value. Gas and groceries, for example, are used up almost as soon as they are purchased. If they can’t be paid for just as quickly, they are a poor debt value. It’s really not a good idea to be paying interest for something you don’t have the use of anymore.

You also want to look at which of your credit cards have the best terms. You may find it advantageous to move debt from one card to another in order to access better terms. You may also find that your bank is willing to extend you better terms to avoid having you move your debt. If you ask, you may find that you can get that “low introductory rate” even if you are an existing customer if you suggest that you might move your balance elsewhere for a better rate. Once you obtain access to low (or no) rate financing, it is very important to track the termination date on those rates. Make sure you pay off your balance by the end of the promotion period or you may find yourself owing all of the accrued interest

Credit can be good for you in that it can help establish a track record for managing finances wisely, it can help you purchase large ticket items over time, it can protect you from having to carry large amounts of cash. You have to learn to protect yourself from credit abuse by not getting into debt beyond your capacity to earn. Analyze your spending and make sure you can afford the things you buy. Never spend more than you earn.

• Installment debt is a type of loan that is paid off over a set period of time by making fixed payments.
• With installment debt, the total interest expense, total number of payments and total amount of payments is known up-front.
• Revolving credit is the kind of “instant credit” available through credit cards.
• With revolving credit, the monthly payment is based on the outstanding monthly balance and changes each month based on new charges and payments. Making the minimum payment will result in a very long payback period and high total interest paid.
• Spending more than you earn over the long haul will leave you with debt you can’t meet the payments on, and insufficient funds to contribute to your savings plans. Spending within your means (using a sound budget) translates to paying yourself first (savings) then being able to service all of your debt and current expenses.