Unit Five – Managing your Debt

 

Learning Objectives

  • To introduce the concepts of credit and debt
  • To explain basic information about the usage of credit cards
  • To explain credit as a form of debt

 

 

Debt

 

What is a Debt?

Debt refers to an amount owed to a person or organisation for funds or money borrowed. It can be represented by a loan, a bond (will be discussed later on), mortgage or other form stating repayment terms and, if applicable, interest requirements. These different forms all imply intent to pay back an amount owed by a specific date, which is set forth in the repayment terms.

 

Positive Debt

When you take out a loan, you automatically owe that money and thus will be in debt. If used wisely, debt can be a great asset. First of all let’s consider when we should or should not use debt. Debt can be used to fund your education or purchase a home (a mortgage). This is recommended because both of these expenditures are actually investments. Hopefully, what you invest in your education will pay dividends (bonuses/payments) later, in terms of higher salary and increased job prospects. Buying a house or land is usually one of the most stable and beneficial investments you can make, considering that real estate tends to appreciate in value. Therefore, these investments are the first two to consider, when acquiring positive debt.

 

Negative Debt

Negative debt is any debt used to buy short-term consumer goods such as clothing, entertainment, electronics, etc. All of these items have a very short life span and usually have no added value when we decide to sell them. Therefore the money we spend on them is really money that we can never get back.

You may also take loans for a vehicle. Though it is something that you will probably lose money on since the value of cars tends to depreciate over time, it is also something for which most people cannot afford to pay cash.

One important aspect of debt that most people neglect is simple record keeping. You should have a file created in which you keep careful track of all debt you accumulate along with a payoff plan. If you can simply do this, you will have more control over your debt than the average consumer. Record keeping is the first step towards controlling your finances and it applies to debt as well as to investments.

 

Tips for Managing Debt

 

  • Shop around. Compare interest rates. Don’t accept your first offer.
  • Keep within your budget.
  • Borrow only what you can afford to pay back regularly and on time.
  • Pay back more and pay more often.
  • Additional payments mean you’ll pay it off sooner and pay less interest in the long run.

 

 

What is credit

 

Credit is a loan of money from someone with the expectation that the money will be paid back at a later date. The most common use of credit is via credit cards. Credit cards are cards commonly issued by financial institutions.

 

Advantages and Disadvantages of credit

 

Using credit can have advantages and disadvantages. If you spend within your means and pay off your balance on time and in full each month, credit cards can serve as a safe, convenient substitute for cash — with the added bonus that they can help you establish and maintain a solid credit history.

 

But if you use them to purchase items you could not otherwise afford — or “max” out your cards to cover routine monthly expenses — credit cards can quickly compound your debt.

 

 

Credit and debt are partially symbiotic in nature however – You can’t have debt without credit, but you can have credit without debt.

 

 

The Truth about Credit Cards

 

Many credit cards charge interest rates run as high as 2 percent a month to 18 percent annually — which can add up quickly if you don’t pay off your balance in full, each lending cycle — usually one month.

 

Consistently carrying over your balances can result in even higher interest rates being charged over time. If you owe money on your credit cards, the wisest thing you can do is to pay off the balance in full as quickly as possible. Otherwise, money that could be going into an interest-bearing savings account is going to pay interest instead.

 

Credit Card Dos and Don’ts

  • Pay the balance in full each month.
  • Don’t make only the minimum payment.
  • If you can’t pay your full credit card charges each month, the best thing is to pay a fixed amount. The second option, is to pay the minimum amount plus an additional amount.
  • Pay a few days before the due date.

 

 

Credit Card Terminology

 

Annual fee – An amount charged to a credit card holder by some creditors to maintain an account. Annual fees are charged regardless of whether a credit card is used or not.

 

Credit limit –The amount of credit you are authorised to use

 

Interest Rate – The percentage charge applied to your credit balance each month

 

Grace period – The period of time from the billing date of your last credit card bill to the due date of your current bill, which is when you can pay in full without being charged interest

 

Late payment fee – A charge added to an account if a required payment is not received by a specific date or received after the grace period.

 

Minimum Monthly payment – The smallest amount or balance that must be paid before the due date.

 

Cash advance fee – the percentage charged for withdrawing money in advance from the credit card.

 

Over-the-limit fees – A charge imposed on some credit accounts for spending more than your credit limit.

 

Interest– is the additional cost that one pays for borrowing money. It is the cost associated with the ability to use the loaned money and is added on to the amount borrowed. For Example: if you borrow money you pay interest, if you lend money you can earn interest.