Give Yourself Some Credit…

By Scott Beckett

The dictionary defines "credit" in many ways, but my favourite definition comes from Webster’s New World Dictionary: "trust in one’s ability to meet payments." This is, quite simply, the essence of credit. This article explores credit in its numerous forms and demonstrates when and where the use of credit is appropriate.

Credit usually involves two parties, a debtor and a creditor. A debtor is someone who owes a debt; a creditor is someone to whom a debt is owed. This debt is usually money but can include goods or property. Most of us are familiar with the common forms of credit which include mortgages, credit cards, charge cards, car loans and other personal loans. We can add to the list bank lines of credit, purchases on account, and all other goods and services we purchase by making payment after receipt.

The wise use of credit revolves around three things: safety, convenience and planned purchases. If you are using credit for any other reason, you may be headed for trouble. If you haven’t budgeted for a purchase, credit is not very convenient in the long term, since you are spending money you don’t have.

Before using credit, it is essential to determine how much you can comfortably afford to purchase. You need to have a plan with financial goals. Credit is difficult to use wisely if you don’t have a clear idea of your current situation with a realistic budget.

Unfortunately, many people think of credit as a way of allowing short-term expenses to exceed income. Optimism and an unrealistic attitude steer one into believing that money will come along to pay all the bills that eventually arrive. Living on credit creates unrealistic ideas about one’s room to spend; credit payments eat up a larger and larger portion of income, to the point that debts are unmanageable.

Never allow credit payments to exceed 15 to 20 per cent of your net income. One of the best ways to avoid the poor use of credit is to save. Although it can be very difficult, we should try to save at least 10 per cent of our income. We tend to respect the money we save and spend it more wisely than money received on credit. It is also a good idea to accumulate three to six months’ expenses in an emergency fund. This further helps avoid the need to use credit.

Banks, trust companies, finance companies, stores and many others are willing to lend money. It is a profitable business because money is expensive to borrow. When buying on credit, it is important to make sure you are not being overcharged. For example, most department store credit cards carry an interest rate of over 20 per cent, while some MasterCard and VISA rates are only around 10 per cent.

If you are purchasing something on your department store credit card because your MasterCard or VISA is full, chances are you can’t afford what you are buying. So don’t buy it. Wait until you can pay cash. The secret is to distinguish the difference between needs and wants. Take care of your needs first, and only then should money be spent for wants.

Match the right form of credit to your needs. If you are always carrying a monthly balance on your credit card, get credit with a low interest rate and low service charges. If you find that you can never make any progress paying a credit card balance, write to request that your spending limit be reduced. If you have a lot of credit cards with high interest rates and they are out of control, consider cancelling them. Use a consolidation loan to pay off all the balances, keeping one card with a low limit for identification when writing cheques and for emergencies.

If you feel you are not using credit wisely or you think you have a problem, there are some excellent services available. I called the Credit Counselling Service of Metropolitan Toronto, an accredited agency of the Ontario Association of Credit Counselling Services (OACCS) that is also affiliated with the National Foundation for Consumer Credit. I was impressed with their caring attitude and their knowledge and service. They provided me with helpful material regarding their services, and sent a short Money Management Quiz that determines whether you are practising good money management skills or need to improve.

According to program manager Laurie Campbell, the purpose of credit counselling services is to help consumers with financial problems by educating and counselling them on personal budgeting, the wise use of credit and planned debt liquidation. It is important to distinguish between "not-for-profit" and "for-profit" credit counsellors. "For-profit" credit counsellors are not regulated or supervised, and many people have discovered that some of these firms charge a lot but deliver very little. Most creditors do not accept debt management proposals that come from organizations other than those credit counselling service agencies affiliated with the OACCS. The National Foundation for Consumer Credit has more than 1,100 affiliated offices in North America, serving over 600,000 people and providing 25,000 community education programs. In 1993, they disbursed more than $1 billion to creditors through debt management programs.

Prudent use of credit is important for another reason. Your payment habits form part of your credit file at the credit bureau. Someone with a consistent history of paying debts in a timely manner is a good credit risk. If you have a poor history of paying debt, creditors may refuse to lend money or may charge more for the use of that money. Often, they will ask for some form of security.

One of the most common myths about the credit bureau is that of a credit rating. There is no such thing. Each creditor has different requirements for the extension of credit, and it would be very difficult for any organization to create a rating system suitable to all creditors. The credit bureau is simply a clearinghouse for credit information. Creditors provide the bureau with factual information on how their customers pay their bills, and the bureau assembles it into a file of their credit history, including their payment history and public record of bankruptcies or judgements. The information reflects an individual’s ability to meet their commitments. In return, the creditor can obtain files on consumers who wish to open accounts with them, and match the files against their own standards for granting credit. The decision to grant credit is made only by the creditor.
Credit is an excellent and convenient source of funds in an emergency or for planned purchases. It is also a common trap that many people fall into at least once in their life. I once heard a very profound statement: "Look at your situation at age 40. You will either be making interest or paying interest, and this is the way it will be for the rest of your life."

(Scott Beckett is the Associate Director of Disability Market Development, PPI Financial Group in Toronto.)