Credit was once defined as "Man's Confidence in Man." But in
fact, the definition of credit today is more like "Man's Confidence
in Himself." Using credit today means you have confidence in your
future ability to pay that debt. Forty years ago, your parents may
have paid cash for their homes and their cars, a largely unheard-of
event today. If they borrowed money at all, chances are it was from
a relative or friend and not a financial institution.
Today debt and instant credit are part of our everyday lives.
The convenience of instant credit, however, has taken its toll.
Many individuals use credit cards to spend more than they earn, and
a few of these people actually build themselves a debt prison from
which some never emerge. On the other hand, those who never use
credit can be denied a loan or credit when they have a justifiable
need or use for it. Using credit establishes a history of financial
responsibility: Until you establish a credit history, your chances
of qualifying for an important loan, such as a mortgage, are
What is the balance between using credit wisely and staying out
of overwhelming debt? Let's look at the facts and some pros and
Debt comes in many forms, and most types help us in our daily
lives -- when used responsibly. Most people cannot buy a home
without some financial help, and many cannot buy a car (especially
a new one) without some sort of financing. The money borrowed to
purchase large-ticket items is called installment debt: The debtor
pays a portion of the total at regular intervals over a specified
period of time. At the end of that time period, the loan with
interest is paid off.
Installment debt allows you to purchase items at a competitive
interest rate: for example, 3% to 7% for a 30-year home mortgage
and 6% to 9% for a car loan. The loan is paid back on an amortizing
schedule, monthly payments of a fixed amount that remain constant
over the life of the loan. At first, most of the monthly payment
consists of interest. In later years, principal begins to be paid
Installment debt is easily budgeted and the debt is eliminated
on a predetermined date. Even for those who may actually have the
cash to purchase the desired item, installment debt can make
financial sense if you can earn a higher return (after taxes) on
your investment of cash than you must pay on your installment
A revolving line of credit, also called "open-ended credit," is
made available to you for use at any time. Examples of revolving
credit are credit cards such as Visa, Mastercard, and department
store cards. When you apply for one of these cards, you receive a
credit limit based on your credit payment history and income. When
you use the credit line, you must make monthly minimum payments
based on the total balance outstanding that month. Some lines of
credit will also have an annual account fee.
While revolving credit is a convenient way to borrow, it can
also become an endless pit of minimum payments that barely cover
the interest due. Many cards charge annual rates of interest of 18%
or higher. As you pay off your debt, the minimum payment is also
reduced, thus extending your payoff period and, consequently, the
interest you pay. Paying just the minimum due on a $2,000 credit
card loan could mean making monthly interest payments for 10 or
Revolving credit, in addition to being convenient, eliminates
the need to carry a lot of cash and can help establish you as a
creditworthy risk for future loans. The itemized monthly statements
also can help you track your expenses. But some people can easily
yield to the temptation that the convenience of credit cards
offers. Impulse buying, failing to compare costs, and purchasing
large items you can't afford are all downfalls brought on by always
available purchasing power. Spending more than you earn in any
given period is a dangerous practice at best, but doing it over an
extended period of time can be financial suicide.
|Installment Debt vs.
|Lower interest rates and an amortizing repayment
schedule can make installment debt a much cheaper alternative to
|Years to Repay
|*Paying higher of 2% minimum monthly payment or
|Sources and Costs of Debt
||Type of Debt
|Banks and Credit Unions
||Low to High
Using Credit Wisely
To use credit intelligently, start by examining the terms of the
card(s) you are currently using. Keeping track of your cards, their
rates, and your current balances will help you to be aware of how
you use credit cards. Increased competition in recent years has led
some credit card companies to offer enticing features to attract
new cardholders, including no annual fees and low interest rates
for an introductory period. (And credit card companies sometimes
will give their introductory rates to existing cardholders so that
they won't transfer their balances to another credit card
Eliminating Credit Card Debt
If you think you may have too much credit card debt, begin to
address it by honestly evaluating your spending habits. Examine
your existing expenses to analyze how your money is spent. You will
most likely be able to identify the problem areas where you are
more likely to spend too much or too readily with credit cards.
Then, based on your current spending practices, create a realistic
budget to pay off your credit card debt in the shortest time
possible while not adding any more debt to it. For assistance, you
may want to turn to your financial professional, who can help you
to allocate your resources wisely to address your credit card
The Role of Debt
Today, carrying installment debt is almost a fact of life.
Mortgages, car loans, or small-business loans (to name a few) are
part of almost everyone's life. On the other hand, carrying credit
card debt is usually not a good idea. At interest rates of 16% and
up, it's hard to justify keeping savings that could pay off that
18% department-store credit card in the bank at 2%.
Debt and credit play increasingly important roles in our lives.
As the aging Baby Boomers get closer to their peak earning years,
many are realizing the need to reduce debt and increase savings.
Even though analyzing your spending habits and creating a budget to
address your debt may seem a little overwhelming, the simplicity of
the philosophy of the Depression era still stands: Never spend more
than you earn. Once you have come to grips with this basic fact,
managing your debt will become far easier and more rewarding.