Credit, or leverage, is the key to wealth building. A business can grow faster because of credit. And an individual can apply leverage to accumulate assets he cannot afford to now. Life is unpredictable and we can never know when we might lose out jobs and be asked to leave our desk in 2 hours. Or a sudden road accident leaves us physically unable to work for a couple of months. Even a sudden illness out of the blue can leave us bedridden for weeks. In such financial emergencies, having a line of credit can be the comfort that is keeping you from a nervous breakdown.
But it is also a debt trap that many people get into, never able to claw their way out. The problem is that it is so tempting to take advantage of attractive credit cards that offer attractive rebates and rewards. But once you get your hands on the pretty plastic, fighting the urge to use it can be challenging to many people. Users who do not plan their cash then make the mistake of paying the minimum amount each month. The outstanding rolls over to the following month with the type of interest that can make your jaw drop.
This interest on outstanding is the killer that is often overlooked by borrowers. Because when the bill arrives with a stated minimum payment, card owners often think that all they need to do is pay the minimum without incurring any charges. This is of course wrong unless it is a special card explicitly stating the non-existence of interest charges. The problem then magnifies when amount owing compounds month-by-month.
Another common credit card hazard occurs when users overlook conditions like upfront payments, flat rates, reducing rates, or an unclear principle to interest breakdown. This is why you should always get a banker to explain terms of borrowing in detail with the aid of amortization tables if necessary. On paper, your cash flow might look at a comfortable level. But in real life, it can often be anything but that case. Negligence can mean that one day, your lifestyle changing access to credit becomes a devil that sucks the life out of you.
Having easy access to money-churning plastic cards can encourage a lot of people to overspend. And flexible repayment plans can misguide borrowers of the real extent of debt they have got into. Risk takers might even use borrowed funds to gamble and speculate. Even though there is nothing wrong in using brought-forward cash, don’t forget prudence and ignore common financial sense.
An example of overspending is when a couple take up a jumbo mortgage loan to purchase a house they can hardly afford. In such cases, should the loss of income happen to just 1 single party, their life can turn upside down. There are however, things like mortgage insurance to protect against unplanned situations.
There are generally 6 areas of financial planning.
1) Cash and credit management
3) Risks management
4) Tax planning
5) Retirement planning
6) Estate planning
Managing cash and credit is the first area. It is the most important as a winning well-executed plan in this area can mean the success of the other 5 areas as well. The same cannot be said of the other 5 areas.
The first step to credit management is to recognize and understand the financial position you are in. This can sound like some accounting lingo. But it merely means put together all your financial statements including cash flow statements and balance sheets. Use basic ratios to find out where you stand financially. This will give you an overview of your financial strength and position.
Which this information, you can then consider key decisions in the use of cash and credit. For example, whether a loan is necessary to acquire investment assets. Very often you will realize that buying with cash is more worthwhile compared to paying interest for an asset-acquiring loan. This is especially when you have excess cash sitting in fixed deposits that pay an interest which is lower than the loan in question. In this instance, you would actually be “making” money by buying in cash.
If you must make use of your credit facilities, keep these 5 things in mind
1) Only take on more debt when there are no other alternatives
2) Be a disciplined paymaster for repayments
3) Do not borrow more than you really need
4) Ensure that you are borrowing an amount that you can comfortably repay
5) Always have an emergency fund stashed somewhere