Uses and Cost of Consumer Credit

Using credit to purchase goods and services may allow consumers to be more efficient, to be more productive or to lead more satisfying lives. There are many valid reasons for using credit. Although using credit increases the amount of money that you can spend on goods and services today, it decreases the amount of money that you will have available to spend later. Since most people expect their income to rise, they expect, not only to be able to make payment on past credit purchases, but also to make new purchases.

Advantages of credit

Consumer credit enables us to have and enjoy goods and services now and to pay for them through payment plans based on future income. Credit cards permit the purchase of goods even when funds are low. If you have established credit, you are better equipped to cope with financial emergencies. Some people consider it safer to use credit cards rather than to carry large amounts of cash. Some people like the convenience of paying for several purchases with one monthly payment. Credit can indicate stability. The fact that lenders consider you a good risk usually means that you are a responsible individual.

Disadvantages of credit

If you don't repay your debts on a timely basis, credit has many disadvantages. Perhaps the greatest disadvantage is the temptation to overspend, and continued overspending leads to serious trouble. Tied into that is the very real cost of a "loan" from the credit card company.

Whether or not credit involves putting up collateral, failure to pay a loan may result in the loss of income, valuable property, and your good reputation. It could also result in court action, wage garnishment, and bankruptcy. Misuse of credit can create serious long-term financial problems, damage to family relationships, and a slowing of progress toward goals. Therefore, credit should be approached with caution and must not be used more extensively than your budget permits.

Credit costs money. It is a service for which you must pay. Paying for your purchases over a period of time is more costly than paying for them in cash. Also, although credit allows more immediate satisfaction of needs and desires, it does not increase total purchasing power. Credit purchases must be paid for out of future income, therefore, credit ties up the use of some future income. Furthermore, if your income does not increase to cover rising costs, your ability to repay credit commitments will be diminished. Therefore, credit should be approached with caution and must not be used more extensively than your budget permits.

Cost of credit. Even with recent reforms, credit card interest is usually exorbitant--in the 15-25 percent range on balances that you carry from month to month. Making minimum payments nearly always guarantees that you will fall further and further behind in any effort to build wealth or to ensure future financial security. It is a service for which you must pay. Paying for your purchases over a period of time is more costly than paying for them in cash. Also, although credit allows more immediate satisfaction of needs and desires, it does not increase total purchasing power. Credit purchases must be paid for out of future income, therefore, credit ties up the use of future income. Furthermore, if your income does not increase to cover rising costs, your ability to repay credit commitments will be diminished.

The Consumer Credit Protection Act, which launched Truth-In-Lending, was a landmark piece of legislation. For the first time, creditors were required to state the cost of borrowing in a common language so that you, the consumer, could figure out exactly what the charges would be. With that information you can compare costs and shop around for the best credit deal.

Many people fool themselves (or live in denial) and think that the cheapest loan is the one with the lowest interest rate and the lowest payments. But that's not the whole story. The length of the loan and the fees you pay are essential in figuring the loan's true cost. Moreover, with a bank card you may find yourself saddled with a higher interest rate at the whim of the bank--with an installment loan, the terms are fixed and can vary only within the terms of the contract.

Example Say you have a credit card you have maxed out at its $5,000 limit. Although you do not make any more purchases on that card, you are only able to pay $100 per month. The current rate on the card is an even 15 percent. If you continue to make only the minimum payment and you add no new purchases to the card, it will take you nearly 6.5 years--yes, that's not a typo--to pay off that balance. And here's the real kicker: You will have spent more than $2,700 in interest charges. What's more, you have lost the chance to invest the money you are shelling out for interest. If you had invested the average monthly interest charge over those 6.5 years in an investment that earned an eight percent return, you would have earned more than $1,750 in the same period of time. What did those credit card purchases cost you, really? Adding what you paid in interest ($2,700) plus what you could have earned in an investment ($1,750), your cost was about $4,450! That $5,000 credit card debt really cost you $9,450.

If you are thinking of borrowing money or opening a credit account, your first step should be to figure out how much it will cost you and whether you can afford it. Then you should shop for the best terms, especially for credit cards. To get the whole picture, consider the following:

• cost of credit cards
• finance charges
• calculation of interest
• grace period
• annual percentage rate (APR)
• early repayment
• tips to lower your credit costs
• debt and the income tax laws

Financial Calculators Automobiles. When purchasing an automobile, you may be faced with the choice between a rebate that reduces the purchase price or low-interest rate financing. This adds another factor you should consider in making a credit decision. Use this auto rebate calculator to help you determine whether you should take advantage of low-interest financing or a manufacturer's rebate. A rebate will reduce your auto loan amount, while low-interest financing lowers your monthly payment. The best option depends on the price of vehicle, the size of the rebate, the interest rate, and the amount you intend to finance.

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