Taking Control of Your Money. Using Credit Wisely

Transcription

1 Taking Control of Your Money Using Credit Wisely

2 Session 4: Using Credit Wisely To help you stay financially healthy you need to understand credit. Credit is access to money that belongs to lenders (e.g. individuals, institutions, finance companies). It offers you the ability to purchase items or services that you cannot pay for right now in exchange for agreeing to pay at a future date with interest. The problem with credit is three-fold. 1. Credit can give you a false sense of financial health. Lenders will often extend credit whether or not it is good for your financial situation. 2. Many people don t consider the final cost of a purchase when interest is taken into consideration, particularly if only minimum monthly payments are made. Interest charges add up quickly and can create a financial burden that it is hard, and sometimes nearly impossible, to overcome. 3. If you take a long time to repay a debt, the lender is happy because they make a lot of money on interest. However, your cost will be higher and you will undoubtedly make more purchases during that period of time. Using credit wisely Here are some important things to note about credit: Borrow only what you need and can afford. If you can t pay off a debt quickly, you can t afford it. It s as simple as that. Credit is sold to us by persuasive marketing strategies that promise happiness and convenience. Credit card companies establish low minimum monthly payments or low introductory rate offers to maximize their profit, not to help you. Ultimately you need to ask yourself, can I afford to take on this debt? And if I do, what other opportunities am I giving up in exchange (e.g. the opportunity for stress-free living, more time for enjoyable activities because you can spend less time earning an income, money to put towards savings and retirement funds)? 2

3 Review your credit card agreements All credit cards are not created equal. There are a number of different credit options available to you if you need a credit card. Use this checklist to find the best credit card for you, or to evaluate any card(s) you may already have. What are the annual fees? Some cards charge a fee, and some don t. Others waive the fee for first-time customers but charge the fee in subsequent years. Be wary of low sign-up rates because when the introductory rate ends you may end up paying a higher fee than on another card. What is the interest rate and how is it calculated? A low interest rate may not be the deciding factor for choosing a credit card. For example, if you pay your balance off each month and never incur interest charges, you may be more interested in other benefits a card may offer. How does the grace period work, if there is one at all? Grace periods refer to the time between the closing date of your billing cycle and the date you have to pay your balance in full. No interest is charged during this period. However, this grace period usually only applies if you are not already carrying a balance and it does not apply to cash advances. What are the incentives or loyalty benefits? Be careful that loyalty benefits outweigh the potential higher interest rates and fees you may pay. Getting rebates or frequent flier miles is usually not a good reason to choose one card over another unless everything else is equal. What is the fine print? Read credit card agreements carefully and ask questions of the lender if you are not clear about something. For example, is there a fee for foreign currency transactions (you buy something when traveling in another country)? Have changes occurred to your credit card since you first signed up? Agreements change over time. When you receive notices in the mail that a change has occurred to your credit card agreement make sure you understand what that change is and re-evaluate whether the card is still the best choice for you. Cut credit costs Credit card use that gets out of control costs you money and delays your ability to invest in your financial future. Try the following to reduce credit costs: Shop for a low-cost or no-fee card. Don t pay fees for cards that offer benefits unless you really need the extra benefit they offer. Use credit for necessary purchases that you cannot immediately afford but can pay for before interest charges start. If you must make a major (large) purchase on a credit card, use a card that has a low interest rate. Review your credit card statements carefully each month for mistakes. Reduce the amount of credit available to you. Cancel cards you don t need. Pay off outstanding balances before taking on more debt. Re-evaluate the amount of debt you re willing to carry in relation to the amount of money you want to save. Pay off cards with highest interest rate first. Consolidate your debts so you pay interest charges on only one card. 3

4 Examine your debt ratio To determine how serious your debt is you need to determine how much of your monthly net income (income after taxes, actual take-home pay) is going toward paying your debt. Don t include expenditures here that go towards housing (e.g. mortgage) or investments. Recall the exercise on budgeting and categorizing your expenditures? As a general guideline, if your debt obligations are: 15% or less of your net monthly income you are in reasonable shape. between 15 and 20% your net monthly income could be a problem, particularly if your financial situation changes for the worse (e.g. you incur more debt, your income decreases). If you are managing to pay these debts while also saving or investing, you may be in a more reasonable position. over 20% of your net monthly income and you may be headed for serious trouble. If this debt is in the form of high interest credit cards or financing charges (e.g. paying for a furniture purchase), you should be working towards reducing your debt obligations, cutting back on expenses, etc. Note: Your particular situation may vary (e.g. housing costs vary widely across the country) and some financial planners are reluctant to put percentages on a debt ratio, but many people find that percentages are a good reference point. If your situation differs greatly from these percentages, be certain that there is good reason for this. Change your debt ratio Should you be concerned about your debt ratio? Compare your debt ratio to the guidelines outlined previously. Does your debt ratio exceed 20 percent? Do you charge more and more and pay with cash less and less? Do you have trouble making payments on time? Do you live payday to payday with little or no savings? Do you use credit to pay for items that you used to pay for cash? Is your net worth negative? Do you let some bills slide and postpone payment for a month? Do you make partial payments instead of paying the entire bill? Do you take out new credit cards to cover additional purchases after you max out the cards you re currently using? Do you regularly use your overdraft on your chequing account? Do you put bills off until the second (or later) notice? Do you bounce cheques or pre-authorized payments? 4

5 Change debt-worsening behaviours Many people have a pattern of debt-worsening behaviours that get them into trouble. You may have acquired debt from others or as a result of circumstances beyond your control (e.g. serious illness) so you need to pay bills promptly and rebuild good credit. On a sheet of paper, write down the behaviours or triggers that get you into spending trouble. Do this without judging yourself, be as honest as possible. Make note of everything that crosses your mind regarding your spending habits (e.g. feeling you must pamper yourself to deal with stress, trying to impress friends and neighbours). A journal can be helpful to identify emotiontriggered spending. To get started answer the following: Why did you take on your first significant debt load? How do you feel about debt? How does spending money make you feel? Do you ever binge shop? If so, what sorts of things trigger the binges? What reaction do you have to advertisements for items that you want but can t afford? Do you believe that paying the minimum amount on your credit card will get the balance paid off? Are you ever surprised by how high your bills are? Do you forget about money that you ve spent? Do you balance your chequing account regularly? Do you have any expensive hobbies or habits? Do you feel competitive with or threatened by those around you? How often do you eat out? When you eat out with friends, do you collect cash from others, charge the meal, and then buy something else with the case instead of paying down your credit card debt? Do you plan your purchases or do you buy on impulse? Determine Your Priorities You may need to think about what your priorities are, how they related to or may be affected by debt and how they fit into a plan for getting out of debt. Think about your priorities, the things that matter deeply to you. Ask yourself: Where does your family fit into the picture? Is taking a second job an option (financially, emotionally)? For your own peace of mind how quickly do you want to be out of debt? What are you willing to sacrifice to get there? What things that are important to you are affected by your debt or may be affected by it if you do not remedy it? This may include anything from not being able to join friends for dinner to having to postpone starting a family)? What goals do you have that may be attainable once you re out of debt? This could be anything form educating children to enjoying a comfortable retirement. As you think about your priorities write down the things that matter most to you, the things that will have an impact on how and why you want to get out of debt Homewood Human Solutions

6 Use your budget to get ahead of your debt With your budget and picture of your debt situation you can strategize how best to tackle your debt. Pay off high-interest debts first and always make the largest payment you can afford each month. Example: You have a balance of $1500 and your annual interest is 21% and make the minimum 3% of balance payment each month, repaying the total will take you more than 14 years and you will have paid more than $1800 in interest (total of $3,300). Pay $5 over the minimum payment per month, you ll save more than $600 on interest and cut more than five years off the repayment time. If you pay $10 more per month, you ll save nearly $900 and eight years of payments. Cut up your cards As soon as you ve paid off the balance on a card, cut it up and close the account. If you must have a card for emergencies or business, consider getting a new no-fee card. Use this only when you can t use cash or a cheque and charge only an amount you can pay off during the grace period. Forget savings for the time being A nest egg is a bad idea only when you re seriously in debt. If you have any money in savings, put the money towards paying off your high-interest debt. Otherwise you could be earning 1 or 2% interest on your savings but paying about 20% interest on your credit cards. Two exceptions are: Hang onto enough money to cover a few month s expenses for emergencies. Don t cash in your RSPs, the tax hit would be worse than the interest on your cards and jeaopardize your future. Check your credit rating When you first borrow money or apply for credit, consumer reporting agencies establish a file on you. On a regular basis, companies that lend money or issue credit cards send information related to the financial transactions they have with you to the consumer reporting agencies. These agencies organize and store this information for six to seven years and they are governed by provincial laws. You can ask for a free copy of your credit report by mail once a year. There are two main credit bureaus in Canada: Equifax Canada and TransUnion of Canada (see the resources section for links to their websites). Details of how to obtain the credit reports are available online but you need to dig deep into their website to find the free credit report. Call them if you are unsure. They have a detailed credit report and credit score reporting service for a fee, but you should use the free service first and later determine if you need to know more. 6

7 Need more help? About Credit Counselling If this course is a wake-up call and you are in serious financial trouble, or recognize that you are heading that way, find a good financial counsellor who will help you identify problem areas and put together a workable plan to get you financially fit. The sooner you call, the better. Credit Counselling Credit Counselling Services can help you if you have trouble with debt. Their goal is to offer you credit counselling at no cost (or low cost). They are non-profit organizations, some run by the government, some attached to a Family Services department, and some independent. Depending on your situation, credit counsellors may simply give you ideas about managing your spending and savings or assist you to manage your debts (e.g. help you to work out a debt management program with creditors or help you obtain a consolidation loan). 7