Education-Wisely

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Using Your Credit Wisely

"What's in your wallet?" Capital One has used that catch phrase in their commercials to try and point out that their credit card is what you should be using. But does it really matter which credit card you have if you aren't wise in your use of it?

Credit as a single word has many definitions in Webster's Dictionary. One of the definitions is "influence or power derived from enjoying the confidence of another or others." When you look at the word credit from a financial point of view, this is most definitely the way it is. Another definition given for the word credit that is relevant to this article is "financial or commercial trustworthiness." When you consider that the topic of this article is a display of financial trustworthiness and "financial" power derived from the confidence that others (in this case creditors/lenders) have in you, you can see the importance of being wise in your financial decision.

A credit card is a tangible object that puts us in a position of receiving trustworthiness and displaying financial power. As you read through this article, you will see how using credit (financial trustworthiness) wisely when using your credit card can help you throughout your life.

Credit as a Tool

Credit is a valuable resource if it is used in a responsible and limited manner. In fact, it can be a very helpful financial tool that will help you when making important financial decisions and investments in your life. Credit can help you to purchase a house or a car. It can help you have revolving funds to help pay for emergency or frivolous expenses. It can also help you establish a financial status that will be a benefit when you really need it to be.

Credit can also be the one thing that causes the most financial grief in your life. If abused, it can tie up income as you are constantly trying to pay off debts while they continue to increase from compounded interest faster than minimum payments are made. Abused credit can also lead to future credit problems that will prevent you from having that house, car, or financial status.

Credit provides a lot of advantages and conveniences. Unfortunately, it has costly pitfalls because of interest rates, finance charges, and annual fees. Unfortunately credit isn't free and if you don't use it wisely it gets to be really expensive.

So where does the problem begin? That will actually depend on the situation. A teenager that hasn't learned much by way of finances may see the money being available without realizing that it has to be paid back. And it doesn't have to be a teenager either. Many adults see credit cards as free money, especially since there is only a minimum payment requirement. It isn't uncommon to see someone with more than five credit cards and over $75,000 in debt racked up on them. Yet they continue to pay minimum payments that altogether may equal $500 thinking that all will be okay. Is it a wonder why we have so many people that file bankruptcy when they can't pay anything off and can't get anymore loans?

It is important to think of credit as a tool that will help you in the long run, not just the short-term. It should make you think more carefully before you make purchases.

Making Smart Decisions

When you are in a store and you have an urge to purchase something on credit that you have found, ask yourself if it is something that you really need right now. If the answer is "no" then you may be better off waiting until you have the cash to buy it. Ah, but it is on sale and you don't want to miss out on the price reduction, right? The next question you ask yourself is whether or not you will be able to pay it off sooner than later. If you don't pay it off until later, the money you saved on the price tag will be spent on finance charges. Will you really save yourself some money?

Robin Holland, senior vice president for customer service operations at Equifax in Atlanta says, "If you don't have the money to pay for an item now, you probably won't have it after the credit-card bill arrives. We need to be wise about the use of credit. If you can't pay for an item in a reasonable amount of time, you shouldn't be charging it."

Smart decision making isn't reserved just to being wise with your spending. It also relates to managing your credit accounts. In fact, one of the smartest decisions you can make about credit accounts happens long before you get any. It is the decision to limit yourself.

What? Credit cards and other loans already have limits, so what is the big deal about limiting yourself? The answer to this is simple; if a credit card limits you to say, $1000, and you need (or so you think) more than that, you can get a second or even a third credit card to give you a spending limit that you desire. This isn't a smart decision. It is a decision that could have a negative affect on your credit history. It is also a decision that could get you in trouble if you use those cards so much that you can't pay them off.

If you want to make smart, self-limiting decisions, do the following:

  • Limit yourself to one major card with a credit limit you can handle. The credit limit will be different for each person so make sure you are deciding for your needs and not what you see someone else getting.
  • Keep monthly charges low. Some people recommend that you should keep the spending to no more than 30-50% of the credit limit. Others may recommend limiting yourself to 15% of the credit limit. Only you can decide for yourself what you should limit on spending.
  • Pay in full the amount due each month. This will save you money (no interest or financing charges) and will also give you the full credit amount available should there be an emergency expense that needs it.
  • Regularly review your account balance where possible. If you can do this over the internet or phone, it will allow you the opportunity to know what your current balance is at the moment of inquiry.
  • Regularly review your credit report. Although this may not directly influence your use of credit, it will let you know what your spending habits are doing to your credit score. This in turn may help you be more self-limiting in your use of credit.

The last smart decision to be mentioned here is your need to design realistic spending and savings plans so that credit can work with you to accomplish them. Having spending and savings plans hopefully will help you to be wiser in your spending habits.

Acquiring Loans

Smart decisions shouldn't be saved just for the spending and payoff side of the responsibility. As you look for loans or credit cards, make sure that you are making smart decisions throughout the process. You need to remember that as much as you want the loan, the bank wants your money. They should be willing to work with your needs and abilities to pay back the loan. At the same time, you shouldn't be so stubborn to think that they have to cater to your most ridiculous requests. Those companies send credit card applications in the mail still need to make money and will send you on your way without a dime if you don't act wisely.

No matter what type of loan you want, but most importantly with credit cards, do a little bit of reading first. You don't have to do research on the Internet, but you do need to read the terms and conditions that are always listed with the applications. You know this section. It is the one with the long paragraphs written with a small font and lots of legal language. They may be trying to save trees by printing it so small, or they may be trying to get you to skip over it instead of reading about the penalties, but regardless of the reason for the small print it is important. Do not pass over it. You may regret it later when you are trying to pay off the loan early and there is an additional fee because of it.

Terms and conditions will tell you what you will be required monthly for payment. It will also tell you the many different ways that you can default on your loan. It will disclose what the APR (annual percentage rate) on the loan is, what the current interest rate is, what the interest rate will become if you miss or are late on a payment, and what other fees you will be charged. It will even disclose to some extent the legal action that will be taken against you.

There is another piece of important information found in the terms and conditions portion that could save a lot of headaches if you make sure to read it. As already mentioned, the interest rate for the card will be disclosed in that section. It will also be disclosed in larger letters throughout the promotional propaganda that comes with the application. You will see that you are getting a low 4.9% interest rate. Then there will be an asterisk (*) next to the advertisement referring you to the small print. When you see this, read the small print and/or the terms and conditions.

More often than not, the asterisk means that the interest rate they are advertising is just an introductory rate. Usually after somewhere between six and twelve months that introductory rate will end and another rate will kick in. The new rate could be a fixed number, such as a common 18.9%. It could also be documented as "prime plus 8%". Prime is not a fixed number. It varies based on the economy and what is happening on Wall Street. It could be as low as 6% (maybe even lower), which means your new interest rate in this scenario would be 14%. Prime could also be as high as 12% (or higher) which means your new interest rate would be 20%. Is this confusing? Don't let it be, otherwise you will be sucked into the pitfall of naiveté regarding credit cards.

Payoffs

No matter what form of credit you are considering you should never borrow unless you can realistically meet the pay-back requirement. For fixed loans, such as mortgages, auto loans, and student loans, the payoff date is fixed based on a payment calculation. Fluid loans, such as credit cards and department store cards, don't have a set pay-off date. They require a minimum amount each month but that is all. In fact, those that finance these types of loans prefer that you don't pay off the balance. They want you to finance it over a few months so that they can make extra money. If you are making smart decisions, you won't purchase more than you can pay back, and you will pay off those purchases as soon as you can.

A common consumer rule-of-thumb is to limit non-mortgage credit payments to no more than 20% of your take-home pay. Obviously you need to have enough money to cover all other expenses you have during the month. However, if you take care of all of your financial obligations and have more than the 20% available to pay off credit debt, by all means do it. The sooner you can pay if off the better but don't let your other debts suffer because of it. By the way, if you are able to cover your financial responsibilities and still have more than 20% of your take home pay available, why use credit cards in the first place?

For fixed debts, such as mortgages, you will have a pre-determined amount that has to be paid on a regular (usually monthly) basis. If you make your payments regularly, you will have it paid off on a specific date as calculated by the amount borrowed, the time frame for repayment, and the interest accrued on the loan. If you are able to make additional payments on this debt, make sure that you indicate that the extra payment should be applied directly to the principal and not interest. This will help to shorten the payment period.

If you were to look at payments schedules for someone that wants to get out of debt, you will see recommendations to pay off the smallest balance first. Once that debt is paid off, the recommendation is to then apply the amount of money from that payment to the payment of the next smallest debt. And it continues on like that. It gets debts paid off sooner. This is a good philosophy to follow for both fluid credit debt and fixed debt (mortgages, auto loans, student loans, etc.).

But let's assume that you weren't smart and you purchased more than you can pay off. What is the wisest decision you can make at this point? Let the creditor know that you are having difficulties that prevent you from making payments on the bill. You won't be able to get out of it altogether without filing bankruptcy. But if you are wise enough to call the creditor and explain your situation, they may be willing to work with you.

As you explain the situation, suggest an alternative payment method. You need to remember, they still need to be paid and if they can work out another payment schedule with you that allows you to pay off the debt, they will likely work with you. Be realistic in your proposal. Chances are they will accept it. However, if you run into problems again, you may be out of luck. Then you risk repossession, eviction, garnished wages, or collection agencies coming after you. It can get costly and unpleasant. More importantly, it has a negative effect on your credit. You will lose that financial power and trustworthiness that you are trying to establish. You will end up having little or no credit again. To make matters worse, it could take you another seven to ten years to re-establish your credit and get it in good standing.

If you want to have financial power and trustworthiness that is manifested through a good credit score and long, positive credit history, you need to be wise in your financial decisions. Start being wise in those decisions as early in your life as you can so that you can quickly gain the credit status that will get you through life and all the financial challenges and needs that pass your way.