Calculating Debt
Is it impossible to exist in today’s world without racking up a pile of debt?
While taking out a mortgage or auto loan may be necessary, credit debt may be what pushes you over the edge. Revolving credit (such as credit cards) can be a lifeline when you need it, or a ball and chain that drags you to the bottom to drown.
What Is Credit?
Credit is not debt. The term “credit” describes a measure of one’s ability to take out a loan or borrow, with some form of guarantee or promise to repay. Interest or loan fees are not credit, but a cost of borrowing.
Loans and debt are the other side of the credit coin – that is, your measure of creditworthiness is how lenders determine whether and how much of a loan to grant you.
Revolving credit debt (such as a credit card) is often easier to acquire. Credit debt also usually incurs a higher rate of interest when unsecured by collateral.
Types of Credit
Whether secured or unsecured, all typical debt is based on credit. For example, credit cards, business and personal lines-of-credit, car loans, student loans, mortgages, loans to small business, or even store accounts for high-end items such as jewelry and furniture etc.
Consumer credit falls into two basic categories:
- Closed-end credit includes familiar contracts such as loans for autos, mortgages, appliance and furniture. An agreement sets forth a:
- Fixed amount of money
- Specific purpose for the money
- Specific time period and Repayment schedule
- Open-end credit is what we consider “credit debt.” Open-end credit is also called “revolving credit” because the debt can rise and fall as you take advantage of the credit that was granted. Borrowers may continue to borrow against the credit available while they are making payments against the balance. You don’t take the money or advance until you need it. The repayment terms for revolving credit can be set for any interval (usually monthly), and require payments that are less than the total amount due. Credit cards, home equity and business lines of credit are open-end credit accounts.
Use Credit Debt Wisely
Borrowers can get into trouble using lines of credit, but it’s generally harder to qualify for this type of credit debt. Plus, personal and business credit lines are closely monitored by the lender.
It’s the ubiquitous credit cards that can wreak havoc on our finances. There are strategies to make your credit cards a useful tool rather than a financial dagger.
Credit Card Debt
Fee-Free versus Promotional Cards
While it might boost your ego to flash that Platinum American Express, some card fees can run upwards to hundred of dollars per year. We recommend applying for the most basic fee-free credit card account that extends revolving credit debt of your required limit.
There are exceptions. For instance, if you are a frequent traveler, you might come out ahead by paying an annual fee for a charge card that builds up points in a mileage plan. Some card plans offer free tickets, insurance, or other perqs and benefits. Analyze carefully to decide whether you’ll come out ahead buying your tickets outright.
Pay More Money Toward Debt
With interest rates up to 19%, revolving credit debt is the most expensive. If you run up your charge cards and pay only the minimum, it will take forever to pay off. Over time, you may pay more in interest than principal. Make a policy to only charge what you can pay off at the end of the month, except in emergency. To pay less interest, pay more toward debt of every sort whenever you can.
Credit Cards Build Or Destroy Credit History
Lenders want to see a solid credit history exceeding 12 months. Practice good borrowing skills to build a solid credit history. Be consistent. Charge moderate amounts. Pay your bills on time. Pay more than the minimum required, preferably the full amount due.
Consolidated Loans Head Off Trouble
Perhaps you lose your job or have a medical emergency. What happens if you can’t pay your bills? If you are on solid ground with your creditors, they will be likely to work with you so seek help immediately. Do not avoid your creditors.
A consolidated loan will pay off your other loans, particularly revolving credit debt. With fewer monthly payments and a lower interest rate, it simplifies your finances and help you get control again.
You can do this yourself but the process may be more effective and less stressful with the guidance of an experienced debt consolidation company. In a future article, we’ll cover consolidated loans in more depth.