Managing Credit

A debt-free lifestyle may be a noble aspiration, but hardly realistic for most of us. Whether it's a home mortgage, a credit card or an installment loan for a vehicle, living with debt is a fact of life. These days, getting credit is often not a problem; it's managing credit wisely that's another matter.

Developing prudent spending and borrowing habits will have a significant impact on the other aspects of your financial life, including saving and investing for retirement or other goals.

When it comes to managing credit, your goal should be to put your money to its best use for your financial situation. Sometimes that may mean taking out a loan for a large purchase instead of depleting all of your available savings. Other times, it may mean forgoing that Caribbean vacation or that luxury purchase until you can pay for it in cash rather than charging it to your credit card.

Good Debt and Bad Debt

In many cases, some degree of debt is necessary and unavoidable. For example, for many of us it is virtually impossible to own a home without borrowing a majority of the purchase price. Similarly, taking out a loan to pay for a car or college tuition can be a "good" form of debt if it prevents you from draining your savings which are better kept on hand for emergencies or put to work in better ways.

Some debt can also provide tax savings for you as well. For instance, interest that you pay on a home mortgage loan or a home equity line of credit typically qualifies as a tax deduction, reducing the amount of your income that is subject to taxation on your federal income tax form. You may also be able to deduct the interest on college tuition loans under certain conditions.

"Bad" debt would include borrowing for discretionary, non-essential purchases that you cannot otherwise afford. Credit card debt is a prime example of "bad" debt. Credit cards usually carry high interest rates and the interest you pay on your credit card purchases cannot be deducted from your income on your federal income tax return.

Five Strategies to Lighten Your Debt Load

• Understand your spending habits
  For one month, keep a record of everything you buy including small purchases such as coffee, soft drinks or newspapers. Sort this list into two categories:
  
  
  • Essential needs, including food, utilities and your mortgage or rent payment
  • Discretionary spending, including dining out, entertainment and other non-essential purchases

  You may be surprised by how much of your monthly income is taken up by discretionary spending. This is the first place you should look to cut back on your spending habits.

• Pay off high interest debt first
  Credit card debt is usually the worst debt you can have because interest rates on credit card balances are typically higher than the interest rate you are charged on other types of debt.
  
  If you carry a balance on more than one credit card, you should begin to pay off the balance of the card which charges the highest interest rate first. Once that debt is paid off, tackle the card with the next highest interest rate, and so on.
  
  
• Pay more than the minimum amount due
  If you only pay the minimum amount due on your credit card bill every month, you aren't doing much to lighten your debt load. In fact, minimum payments typically only cover the interest payment on your outstanding balance for that month.
  
  To reduce your debt load successfully, you must pay on the principal amount, as well. That means, you should always pay more than the minimum amount due on your monthly credit card bill.
  
  
• Pay for high-price items in full at the time of purchase
  Here's a good rule-of-thumb for deciding what should go on your credit card: If you cannot pay for a purchase in two months or less, then do not make the purchase with your credit card.
  
  If you do, there's a good chance the debt will remain on your credit card and accumulate interest, making it harder to pay off the balance over time. Save for high-priced items such as furniture or appliances until you can pay for the item in full, with cash, at the time of purchase.
  
  
• Use home equity only for home improvement
  Although a home equity line of credit can be "good debt," it is important to use it wisely. Because a home equity line is tied to the value of your residence, use this debt only for purchases that will increase the value of your home, such as remodeling projects. Never tap into your home equity for vacations or other discretionary spending.

Dearborn & Creggs Can Help

Managing your credit wisely is crucial to your meeting your day-to-day responsibilities and fulfilling your lifetime goals. Your Dearborn & Creggs financial representatives can help you create a plan to manage your credit and pay off debt so that a debt-free lifestyle is closer to your reach.