Commonly Asked Questions About Credit And Debt
InCharge Institute of America, Inc.
What is credit?
The term "credit" implies that goods, services,
or money are received in exchange for a promise to pay a
sum of money at a later time. A "credit card"
offers immediate access to services and merchandise to
consumers who may or may not be able to make the full
payment at once. Credit cards allow consumers the
flexibility and leverage to make purchases with the
promise of paying later.
When used properly, credit is an ideal financial tool.
When used foolishly, credit can cost an exorbitant amount
of money in interest and fees. The misuse of credit can
also hurt an individual's ability to purchase homes or
cars, as well as endanger future financial stability.
How can consumers control credit and avoid
Today's consumers benefit significantly from the
convenience of credit. Credit cards offer such benefits as
frequent-flyer miles and cash-back bonuses, and they are
especially useful for large purchases, emergency
situations, identification, reservations, and protection
Unfortunately, millions of consumers misuse credit cards
beyond their financial means. The use of credit results in
costly interest payments and late fees, impulse buying,
overextended lifestyles, and unnecessary stress such as
harassing telephone calls from collectors.
What is the debt-to-income ratio?
The debt-to-income ratio is an important concept. The
ratio is calculated by dividing the amount of debt
payments per month (excluding mortgage or rent) by the
monthly gross income.
For example, the debt-to-income ratio is 15% for someone
who earns $3,000 per month and pays $450 per month in
credit card and loan payments (450/3,000 = .15 or 15%). As
a general rule of thumb, a personal debt-to-income ratio
of less than 20% is considered safe. A ratio higher than
20% may be a sign of future financial trouble.
Ideally, individuals will carry little debt so that their
income can be saved, invested, or spent on something of
lasting value, rather than spending their disposable
income on interest and late fees.
What's the trouble with making minimum
Consumers often mistakenly believe that making a minimum
payment on a credit card is a reasonable financial move.
In reality, minimum payments make only a very small dent
into the principal, or the original amount borrowed.
Picture, for example, a consumer who is $5,000 in debt on
a credit card that carries a 17 percent interest rate. The
creditor requires only a minimum monthly payment of 2
percent, or $100. Of that $100, a mere $29.17 would be
applied to the principal if the consumer made the minimum
monthly payment. At that rate, it would take nearly 30
years-and cost thousands of dollars over the principal
amount-for the individual to pay off the debt.
What about cash advances on a credit
Credit card holders often mistake cash advances (getting
cash through a credit card) as free money. In fact,
consumers must pay back the amount of the cash advance at
a typically high interest rate, as well as a cash advance
fee. For example, an individual who takes a credit card
cash advance of $500 will ultimately pay back more than
$600 if all payments are made on time within one year. (If
any payment is late, late fees or higher interest rates
may also apply.)
People sometimes take out cash advances in order to pay
off existing credit card balances, viewing this as a
temporary solution to credit woes. In reality, this method
of paying bills is one of the worst financial decisions a
consumer can make, as it compounds the problem. The
borrower will ultimately end up paying off the new debt at
a higher interest rate, thereby losing even more money.
What are the alternatives?
People who find themselves in such situations may consider
alternatives to costly cash advances. One option is to
contact creditors, identify the problem, and attempt to
negotiate a short-term arrangement that satisfies both
There are instances, though when individuals may wish to
consider rearranging their debts in order to obtain
reduced interest rates or consolidate debts into one
payment. An example is an unsecured debt consolidation
loan. The purpose of obtaining this type of loan is to
eliminate multiple credit card bills and receive favorable
Another possibility that comes with some danger is a home
equity, or secured, loan. What many people fail to realize
is that by taking a second mortgage or home equity loan to
pay off credit card debt, families may be putting their
home at risk. The home serves as collateral to secure the
loan, and can therefore be taken away if they default on
Consumers who choose to obtain a home equity or dept
consolidation loan should immediately close credit card
accounts and begin a spending plan.
How can I use credit wisely?
The practice of using credit wisely involves:
Paying off balances by the due date to avoid interest
charges and late fees
Charging only as much as can be paid for in one
People who are unable to pay balances in full will
benefit from paying off much more than the minimum
amount on each statement and refraining from continued