The danger of easy credit is something that most people will implicitly know. It is the tendency and temptation of going deeper and deeper into debt without remorse. Although investors and entrepreneurs might have a bigger stomach for high debt levels, they also usually possess the skills to churn a profit out of it. The same cannot be said of regular folks who are contented just to get by with a regular blue-collar job.
But times are changing. 20 years ago, newly-wed couples might be more prudent with their finances by borrowing as little as possible for a mortgage to purchase a home. These days, using too little leverage can be perceived by many as being weak, ill-informed, and not money savvy. So much has the trends and people’s mindsets changed that lender frequently give out 90% loan to values on real estate. And there are also avenues to explore to obtain 100%.
There are very logical reasons why leverage is getting so popular. So much so that at times, lesser gearing results in higher risks when inflation is taken into account. Whatever the case you may be in, by incorporating 5 rules of credit into your mindset, you should be able to navigate through debt without getting into deep trouble.
1) Don’t go into debt because of luxuries
When you are cash strapped, few people will blame you if you had to max out your credit card at the supermarket to feed your family. But if you are to go on a swiping rampage with vengeance at the luxury boutiques for designer bags and leather shoes, you probably deserve whatever is coming to you in the mail.
Always ask yourself if what you are buying is something is necessary. This sounds simple enough. But for many people, defining a line that separates necessity and luxury can be incomprehensible. If that is so, then the obvious activity to do first is to define what is “necessity” and what is “luxury”. Credit facilities also comes with strings attached. You need to understand what you are taking on for getting into debt.
2) Repay what you owe
I’m unable to understand people who refuse to pay back what they borrowed. Just like I cannot understand why certain businesses can sell faulty products and refuse a refund to a customer. But I can understand that different individuals are brought up with different values. And the only people who have the right to determine what is right or wrong are the authorities that govern a territory.
One of the features that come with bill repayments is that cardholders often only have to repay a minimum amount and roll over the outstanding to the following month. Sometimes an interest is charged on this outstanding amount while sometimes it is not. It really depends on the terms of the card in question. But many times, cardholders forget about this and pays the minimum amount only. They only realize the high interest on outstanding balances when it has accumulated to a significant sum.
Borrowers also have to make it a point to understand how interest is charged on their facilities. For example, term loans often come in 2 forms of interest. A flat rate and a reducing balance. A flat rate means to charge on the original amount while reducing balance refers to charges on the outstanding balance after each repayment.
In any case, if you took the action of borrowing, you must repay what is due.
3) Only borrow what is required
If all you need is $20,000, why would you go out and take on a $50,000 debt. The psychology behind over-borrowing is interesting and complex. When someone has taken the first step to borrow $20,000, it becomes lesser of a mental barrier to borrow an additional $30,000. Especially when a banker offers that to you with no additional hassle. The drawback is that when $20,000 is needed for a necessity, $30,000 of a $50,000 loan will most probably go to luxuries. Only borrow what is required.
4) Can you afford it?
For debt obligations with fixed instalment schedules, it is important to plan out your finances to see if you can realistically afford the loan. When we are talking about term loans where the monthly repayment can be determined, there is no excuses for defaults. This is because you should know beforehand whether you income is able to support these payments. If you had taken up a loan knowing that instalments make up 80% of your monthly salary, you are voluntarily looking for trouble.
There are also a lot of opportunities to refinance credit and debt with lower rates. Most people are not aware of this or are just plain lazy to look for them. Debt consolidation services have been around for a long time. Remember that these things are available and you owe it to yourself to review available deals in the market for refinancing opportunities.
For credit cards, make it a point to monitor what you owe and use cash to repay those that have a higher interest first. Also take into account of penalty fees to avoid falling into those traps.
5) Emergency fund
Nobody can tell what can happen in the future. People lose their jobs everyday and economies and collapse without warning. Things can happen and put you out of business quickly. And when that happens you could be unable to fulfil your debt obligations until you find another stable stream of income.
This is why people buy insurance and keep emergency funds in the cookie jar. At times like these, failing to pay can adversely compound your credit mercilessly in a very short time. Before you know it, you terrible credit can ignite the fear of lenders. Leading them to make immediate recalls of your facilities. This can be a financial disaster for many people. With emergency funds in place, you can at least meet your financial obligations in the short to medium term until you identify a new course of consistent income. Saving you from credit catastrophe.