Chapter 3: Use Credit to Your Advantage
Credit use is not without its pitfalls. Interest rates and fees can dramatically increase the cost of a purchase made on credit, and generous credit lines make overspending easy. However, when used correctly, credit can be an excellent tool, and it’s the only way to build a positive credit history – which will help you get what you want in the future at the lowest cost.
Wise Use – and Misuse
There are many appropriate uses for credit cards. Because of the protections provided and fact that the money is not immediately deducted from your checking account, it is a good payment option for on-line purchases, airline tickets, car rentals, hotel rooms, and other products and services that require advance payment. Furthermore, it makes it easier to track your spending since you receive detailed account statements. With some cards, you can even accumulate points for such goodies as airline tickets, cash back rewards, and discounted merchandise. Best of all, if your card has a grace period and you pay off your balance in full each month, you get all of these benefits without having to pay any interest.
Many people get into trouble when they see their credit line as “extra cash.” It is not a bonus for vacations or money for emergencies (that is what savings is for). Most importantly, it is not additional income to get you through a shortfall until the next month. Using it that way may help temporarily, but it will make the next month more stressful when the same cash flow problems arise – but with more debt to pay.
It is best to use close-ended credit for something that will provide a long-term benefit. For example, taking out a mortgage to buy a home provides your family with a place to live and can also be an investment because most homes increase in value over time. However, even if it will provide a benefit, it is important to make sure that you can comfortably afford the monthly payment before you borrow. Don’t just rely on the lender’s approval amount – take a look at your budget to see how much money you have available to make payments. Remember, once you sign the loan papers, you are legally obligated to pay the loan back under the set terms.
- Only charge the amount you can afford to repay when the bill comes due.
- Know your due dates, and always pay on time. Late payments can be reflected on your credit report and lower your score.
- If you have debt now, repay it as quickly as possible.
- Avoid expensive, high-penalty loans that that can work against you.
- Keep your charge receipts in an envelope with a running total on the outside. If the total exceeds an amount you consider appropriate, curtail your spending.
- Avoid shopping in stores where you know you will be tempted to spend more than you can afford to repay.
- Save monthly for such periodic and emergency expenses as vehicle maintenance, medical bills, holiday gifts, and vacations. That way, you won’t need to use credit to cover these expenses, or, if you do charge them, you can pay the balance in full when the bill arrives.
- Limit the number of open credit card accounts you have. It’s much easier to keep track of your total outstanding debt with just a couple of accounts.
- If you are having a hard time using credit responsibility, it may be best to not have any active accounts until you can make changes, even if it hurts your credit score.
Credit To Avoid
Not all credit is created equal. There are some loans on the market today that are especially costly for consumers and should be avoided:
- Payday loans – This is a way to borrow from your future income. You write a check to the lender for the amount you wish to borrow plus a fee. The check is typically held until your next payday, at which time you can either redeem the check by paying the face amount or allow the check to be cashed. If you can’t afford to cover the check, you may roll it over for another term by writing another check, which will result in another set of fees being added to the balance. With an average annual interest rate of more than 400 percent, payday loans are no bargain.
- Car title loans – Car title loans are promoted as small emergency loans but because the interest rate is often in the triple digits, repayment can be difficult and expensive. You don’t need good credit or often even a job to receive a car title loan – just sign over your title as collateral and hand in an extra set of keys. The typical repayment period is one month. Though most loans are for $1000 or less, the finance charges quickly rack up, and it is possible to lose your vehicle if you can’t meet the payments.
- Pawn shop loans – You take a consumer good, such as an electronic device or jewelry, to the pawn shop and are given a short-term loan in exchange for leaving the item there as collateral. If you pay back the loan, including interest, on time, you get the item back. However, if you fail to repay or renew the loan, your item can be sold. The APR for pawn shop loans are typically around 120-300 percent, much higher than the rate charged on credit cards. Many pawn shops also charge additional fees for insurance and storage.