If used carefully, credit can be a helpful financial tool. For example, using credit to purchase a home now, rather than trying to save up the whole purchase price, makes financial sense. The home provides a place to live that will perhaps increase in value and the mortgage interest offers a tax deduction. Credit may also help you deal promptly with costly emergencies.
Many consumers turn to credit when faced with unexpected home or auto repairs, as well as medical emergencies. And credit offers convenience, enabling you to rent a car or hotel room or buy airline tickets over the phone or online. In many situations, credit offers peace of mind; there is no need to carry large amounts of cash when shopping or traveling.
Despite all the advantages and conveniences credit can provide, there are some pitfalls associated with credit use. Credit can be expensive. Interest rates (often ranging from 14% to 22%), finance charges, annual fees, and penalties can dramatically increase the cost of any purchase made on credit. Then, there is a tendency to overspend on credit. It is much easier to spend more than you can afford when all you have to do is pull out the plastic. Overextension gets thousands of consumers into financial trouble every year.
It is possible to have the best of both worlds, though. Designing a realistic spending and savings plan so
you are aware of how much credit you can afford, as well as comparing the cost of credit and shopping around for the best deals, will help you avoid credit trouble.
Here are a few more tips:
• Keep your charge receipts in an envelope with a running total on the outside. If the total exceeds an amount you consider appropriate, you know it’s time to curtail your spending.
• Save monthly for expenses such as auto maintenance, holiday gifts, and the kids’ school clothes. That way you don’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.
• Monitor interest rates. Choose lower-rate financing options whenever possible.
• Limit the number of open credit card accounts you have. You don’t need more than one or two credit cards, and it’s much easier to keep track of your total outstanding debt with just a couple of accounts.
How Much Debt Is OK?
As a rule, no more than 15% of your net (take home) income should be committed to consumer debt payments each month. Another way to determine how much debt is appropriate for you to carry is to first complete a family budget. The amount remaining after you deduct your monthly savings and living expenses from your net income is the most you should have going to debt repayment. If you’re sending more than that to your creditors each month, you may want to consider credit coaching to help you reduce your debt load.