Is it even possible these days, to go through life without taking on some debt?
Just when you think things are working out and you are doing well and the money left in your savings account would last you till the next 3 months a loved might fall sick and need to go through a major medical procedure which they never anticipated.
There are a plethora of reasons —good reasons— why people rack up debts.
Here’s what makes it even scarier:
Most people simply do not have the financial education or experience necessary to make good financial decisions— these people may end up relying on credit cards or taking out high-interest loans because they don’t know any better.
To keep debts from harming you, here are 4 basics things you need to know:
1. Are Credits the same as Debts?
Yes and No.
Debt is what you owe. It is money you have already borrowed, and are probably paying interest on. A car loan or the balance on your credit card is debt.
Credit, however; is the maximum amount of money you are permitted to borrow it's sometimes called your credit limit. You haven’t borrowed it yet, but you can if you want to. Thus, the credit limit on your credit cards is your credit.
Credit cards are used to purchase things. The credit company that issued the card pays for what you purchased (typically within a day or two) and puts the amount on your bill (that becomes your balance), thereby lending you that money. If you pay up your bill in full by the due date, your issuer won’t charge any interest for the money you have borrowed. If you don't, you’ll be charged interest. You are in debt until you pay your bill in full.
So debt is money you’ve borrowed while credit is how much money you are eligible to borrow.
2. Why Care About Credit Utilization?
Say you have a credit card that permits you to borrow up to $20,000 and you currently have $10,000 being used — that means your credit utilization ratio would be 50%.
“But why should I care?” You wonder.
Here’s why you should care:
The higher your utilization ratio, the less likely it is that future lenders will be willing to borrow your money, and even if they do; you'll most likely be required to pay higher interest rates on future borrowing.
And according to most experts, it’s safer to keep your credit utilization ratio below 30% — either across all your cards or on each card — because going above 30% will progressively pose serious damage to your creditworthiness.
Say you have 2 cards, A and B
Card A has an outstanding balance of $5000, and a total credit limit of $20,000.
Card B has an outstanding balance of $5000 and a total credit limit of $10,000.
Same can be done for card B separately.
However, if we wish to calculate the overall utilization, we must first obtain the sum of the balances ($5,000 + $5,000 = $10,000), and the sum of the credit limits ($20,000 + $10,000 = $30,000). We then divide the two ($10,000 / $30,000 = 0.33) and multiply the result by 100. The result is our total credit utilization – 0.33 x 100 = 33%.
How to improve your credit utilization ratio
Request higher credit limit from your issuer: If you’ve been paying your bills consistently and timely. You can call your issuer and ask for an increase in credit; this will help drive down your utilization ratio.
Set up balance alerts: To prevent yourself from overspending, you can set up SMS alerts whenever you've reach led a threshold of spending monthly.
Pay off your bill mid-cycle: You don't have to wait until your bill is due before paying; making payments throughout the month will help keep your total balance down.
3. Credit bureaus
If you were to approach me out of the blue for say a $20,000 loan I definitely wouldn't lend it to you because I hardly know you.
Heck, I probably met you only about 5 minutes ago; before then I've never seen you in my life, and I've never had any transaction with you before now and as such don't know if you can or will eventually pay me back.
But what if you had known my uncle Ben for close to 3 years? And he happens to know a thing or two about you and how well you can be trusted with money, he probably also knows a few people who have lent you money. You can get him to put in a good word for you by telling me how credit-worthy you are?
What good old uncle Ben did, is what credit bureaus do, they only take it a notch higher They collect and maintain consumer credit information then make it available to lenders in the form of a credit report. There are 3 major credit bureaus in the United States: Equifax, Experian, and TransUnion.
When creditors and lenders want to determine how credit-worthy you are, they'll most likely check your credit with one or all three of these credit bureaus.
To ensure that these bureaus don't make mistakes in people’s credit reports, the government allows people to request one free credit report from each of the three major credit bureaus each year. These can be requested at My Free Credit Score.
4. Debt consolidation
Some people consider it too much mental stress and frustration to keep tabs on their numerous loans and bills, so they opt for debt consolidation.
Debt consolidation means that the consumer takes a loan, usually from a bank or a finance company, and uses that loan to pay off all of their debts. The goal is to merge or “consolidate” all of their debts into one single loan; thus eliminating the need to constantly keep tabs on a confusing assortment of debts.
The catch, however; is: not all debt consolidation firms operate the same way and consumers should take care to review a firm's business practices before agreeing to its services.