Lesson 4: How Much Credit Can You Afford?

MYM-3-03

Do You Want to Use Credit?

You have probably received offers from credit card issuers in the mail. Here are some ideas to help you decide if you are ready to use credit, how to choose a company and how to use credit responsibly.

Borrowing money is not good or bad in itself. When you use credit, you are paying to use someone else’s money. It is up to you to pay back what you borrowed by an agreed upon date at a specified cost to you.

A Few Common Forms of Consumer Credit Multi-purpose revolving credit cards-offered by a multitude of banks, credit unions, and consumer-product companies (such as GTE, General Motors, etc.) and accepted by thousands of businesses. Because accounts are accessed by a credit card (such as Visa, MasterCard, and Discover), they are usually called bank cards. These are open-end accounts with a set credit limit and, usually, monthly billing. Single-purpose credit cards-offered by gasoline companies, department stores, and specialty stores where the card can be used only in the issuing business (including its multiple locations). These usually are revolving accounts with monthly billing (but may be "charge accounts" requiring full payment each month). Charge cards-similar to bank cards allowing holders to make purchases at numerous businesses, but the entire balance charged must be repaid within 30 days. Also known as travel and entertainment (T&E) cards, the best known of which include the traditional cards from American Express and Diners’ Club. (These companies also may have cards that are revolving accounts). Home equity loans-the difference between the appraised market value of your home and any mortgage debt owed is the "equity" that you have in your property. Some financial institutions offer a "home equity loan" based on your equity (usually a percentage of your equity and secured with a second mortgage). With a home equity installment loan, a specific amount is borrowed for a fixed time period with fixed monthly payments. With a home equity line of credit, a maximum loan amount is set and the loan operates as open-end credit and often is accessed with a credit card issued on the account. These line-of-credit loans may have a variable interest rate and a flexible repayment schedule. Normally, home equity loans are used to make improvements on the property or to purchase major durable goods (appliances, autos, etc.). It is dangerous to use a home equity line of credit when purchasing general consumer items or services that will be used up long before the loan is repaid. The risk is loss of your home.

Advantages of Credit

• During inflationary times when the dollar buys fewer goods, you can repay a debt with cheaper dollars.
• It may be possible to buy some goods at a lower price now than in the future. For example, if you plan to buy a refrigerator and it goes on sale, using credit might allow you to buy the refrigerator at a lower price than if you saved the cash and then had to pay full price. When deciding on the best option, be sure to take into account the interest you will pay.
• Credit cards are convenient to use and safer than carrying large amounts of cash.
• Credit allows you to buy items you cannot afford to pay for immediately. Examples include buying a house or a car.
• Some services such as renting an automobile or hotel accommodations are difficult to obtain without a credit card.
• Some interest costs for home equity loans may be deductible if you itemize deductions on your income tax return. (Check with your tax preparer.)
• Some credit card programs offer air miles or bonus points for use of the card.

Disadvantages of Credit

• You may be tempted to buy more than you really need because it is easy to say, "charge it."
• Instead of comparison shopping for the best price, you may shop only at stores where you have credit.
• Buying on credit can be habit-forming and can add 20 percent or more to the cost of goods and services.
• Cards that offer air miles or bonus points usually are more costly. They frequently charge a fee for the card, charge a fee for the transaction, charge a higher interest rate, or calculate the interest using a method that is more expensive to the consumer.