Unfortunately, many individuals end up deep in debt, because they do not use credit wisely and spend more money than they can repay each month. The following example shows how interest compounds when you only pay the minimum amount on your balance.

Credit Card Debt Multiplier

$3,000 Balance

Interest Rate

Time To Pay Off

Total Interest

Total Cost

Pay Minimum
(2.5% of balance)

18%

11%

21 yrs. 11 mos.

14 yrs. 9 mos.

$4,115

$1,606

$7,115

$4,606

Pay $100/mo.

18%

11%

3 yrs. 5 mos.

3 yrs.

$1,015

$ 524

$4,015

$3,524

In the example above, if you only paid the minimum each month, it would take you almost 22 years to pay a $3,000 balance on a card charging 18 percent. The best strategy is to look for the lowest interest rate you can find, spend wisely and pay the entire balance at the end of each billing cycle.

Stick To A Budget

A budget is a tool for knowing where your money comes from (income) and planning where it goes (saving and spending). To avoid spending more than you have, create a personal budget, and stick to it.

Be A Smart Spender

Before purchasing something with credit, ask:

Do I really need this?
Is it in my budget?
Should I just pay cash to buy this?
Can I afford to pay for this when the credit card bill is due?

Understand Credit Terms

Make sure you understand the following credit-related terminology.

Annual percentage rate (APR). The rate of interest (expressed as a percentage such as 8.75 percent) charged for a loan over a year's time. The APR includes interest, transaction fees and service fees.
Bankruptcy is the legal process when an individual's or organization's assets are turned over to a trustee and used to pay outstanding debts.
Cash advances allow you to borrow cash, up to a certain dollar limit or up to a percentage of your credit limit. The APR for cash advances is usually higher than for purchases, and other fees may apply.
Credit limit is the maximum amount — including purchases, cash advances, balance transfers, fees and finance charges — you may spend using a credit card, based on the credit issuer’s opinion of your ability to repay debt. If you exceed this amount, you may have to pay an over-the-limit fee.
Finance charge is the cost of borrowing money on credit. You incur a finance charge when you do not pay a credit card balance in full within a single payment period.
Grace period is the time from the date a credit card bill is calculated until the bill’s due date, usually 25 days. If you pay the previous balance in full and on time, you owe no interest or finance charges on purchases made during the grace period.
Interest is the cost of using money with a loan or credit card, expressed as a percentage of the amount you borrow.
Late fee is a charge for not making your payment on time.
Minimum payment is the lowest amount you are required to pay your lender each month. With credit cards, it is usually 2 percent to 4 percent of your balance.
Previous balance is the amount not paid by the previous bill’s due date.

Safe Credit Use

When you have a credit card or loan, be responsible.

Think ahead. Decide exactly how you will use credit.
Do not spend more than you can repay each month.
Pay bills on time and in full. Never skip a payment.
Pay as much as you can if you cannot afford the entire balance. Avoid paying only the minimum due.
Limit the number of credit cards you own. You probably do not need more than two.
Keep copies of sales slips and compare charges when your monthly statements arrive. Call your company immediately if you see a discrepancy.
Never lend your credit card to friends.
Keep your credit card number in a safe place. If your card is lost or stolen, report it immediately to the issuer of the card.

Use Credit For	Do Not Use Credit For
Items that appreciate in value (a home or home improvements). Furthering your education or enhancing your trade skills. Items that have value longer than it takes to pay for them (a vehicle or furniture).	Non-essential goods and services (vacations, dining out, clothing or holiday gifts). Exception: When you can afford to pay these charges in full upon receiving your statement.

Self Test #2

Fill in the blank.

A saving and spending plan is called a ____________.
Avoid charging more than you can __________ each month.
Use credit for items that ____________ in value or provide ____________.
It is best to pay credit card bills on ___________ and in ____________.

Answers

Next: Monitoring Your Credit

Updated Thursday, December 17, 2009