Being cautious in resorting to credit and debt is always smart, but being totally credit-averse isn’t. Credit is not necessarily a monster that can ruin your life without a warning. When used right, credit can end up cheaper than using your own cash savings. It also can allow you get into a better situation when it helps you, for example, pay for education or start a business.
What really determines whether credit is a friend or foe is how you research and seriously take every credit situation. Having a thorough understanding of the cost of credit is also a must to make sure that your calculations are realistic, and that you will be able to pay off your loan without hiccups.
Here are a few points that you must keep in mind when you’re looking for financing:
Check the cost
Credit is money that comes at a price. Knowing what interest rate you will be charged is a no brainer. But interest isn’t the only cost. You must look at any charges or fees that come with the loans. These can add up to a substantial amount. In addition, question your lender about how the interest rate is calculated and paid. In dealing with creditors, it is important that you ask to be walked through the steps of these calculations. In addition, once you get your table of payments, make sure that it all adds up the way you expect it. Any inconsistencies could point to where fees and charges are added or rates are calculated differently than your expectations.
Compare to cash
Assuming you’ve sufficient savings for your required purchase, now it is time to check what makes more sense – cash or credit. To make this decision, take into consideration three items: the previously calculated cost of credit, the term of the loan and expected inflation and any penalties involved in early settlement. If your interest rate is low (and cost of money is therefore low), credit may make a lot more sense than being cash strapped, yet debt free. This is especially true if your loan terms are favorable, and you won’t have to shell out much in penalty, unpaid interest, etc. if you decide to settle the loan early.
Does it make sense?
You need to look at your individual situation and how much debt you already have accumulated. For example, financing a vacation may make a lot of sense, but if you’ve already taken a couple of expensive loans and your monthly payments began to require you to dig into savings, you may need to take a serious look at how much you can afford to pay before adding any more credit. It is easy to be lured with multiple small payments to committ to purchases or financing schemes that add up to an intolerable burden. With that in mind, don’t consider any new credit decision in isolation from the rest of your overall credit commitments. In addition, be your own advocate even if a bank representative pushes the benefits, advantages or perks that come with loan.
Have a time frame
Many may be aware of the marshmallow test where children’s self-control is measured by their decision to take one marshmallow now or two later. Unfortunately, many adults may be tempted to rush into instant purchase gratification because of the availability of credit or cash in their bank account. Regardless of where the money comes from, having a long-term plan for your spending can shield you – and your savings – from getting into unnecessary purchases. All you need is to be clear about what you need and wait for the right moment when banks terms are favorable and you’re in a financial position that can help you get what you want without unnecessary risk.
Rania Oteify a former Gulf News Business Features Editor is currently a Seattle-based editor.
