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Learn the Language | Budget and Save | Save and Invest | Take Control of Debt | Protect Your Wealth
Remember the definition of net worth (wealth)?
Assets – Liabilities = Net Worth
Liabilities are your debts. Debt reduces net worth. Plus, the interest you pay on debt, including credit card debt, is money that cannot be saved or invested—it’s just gone. Debt is a tool to be used wisely for such things as buying a house. If not used wisely, debt can easily get out of hand. For example, putting day-to-day expenses—like groceries or utility bills—on a credit card and not paying off the balance monthly can lead to debt overload.
Lots of people are mired in debt. In some cases, they could not control the causes of their debt. However, in some instances they could have.
Many people get into serious debt because they:
- Experienced financial stresses caused by unemployment, medical bills or divorce.
- Could not control spending, did not plan for the future and did not save money.
- Lacked knowledge of financial and credit matters.
Tips for controlling debt:
- Develop a budget and stick to it.
- Save money so you’re prepared for unforeseen circumstances.
- You should have at least three to six months of living expenses stashed in your rainy day savings account, because as the poet Longfellow put it, “Into each life some rain must fall.
When faced with a choice of financing a purchase, it may be a better financial decision to choose a less expensive model of the same product and save or invest the difference.
Pay off credit card balances monthly.
If you must borrow, learn everything about the loan, including interest rate, fees and penalties for late payments or early repayment.
WHY PEOPLE GET INTO TROUBLE WITH DEBT:
When you take out a loan, you repay the principal, which is the amount borrowed, plus interest, the amount charged for lending you the money.
Remember the discussion about earning compound interest? The interest on your monthly balance is a good example of compound interest that you pay. The interest is added to your bill, and the next month interest is charged on that amount and on the outstanding balance.
The bottom line on interest is that those who know about interest earn it; those who don’t, pay it.
Do you need to reduce your credit card debt? Here are some suggestions.
- Pay cash.
- Set a monthly limit on charging, and keep a written record so you don’t exceed that amount.
- Limit the number of credit cards you have. Cut up all but one of your cards. Stash that one out of sight, and use it only in emergencies.
- Choose the card with the lowest interest rate and no (or very low) annual fee. But beware of low introductory interest rates offered by mail. These rates often skyrocket after the first few months. Don’t apply for credit cards to get a free gift or a discount on a purchase.
- Steer clear of blank checks that financial services companies send you. These checks are cash advances that may carry a higher interest rate than typical charges.
- Pay bills on time to avoid late charges or increased interest rates.
Those who have used credit will have a credit report that shows everything about their payment history, including late payments. The information in your credit report is used to create your credit
score. A credit score is a number generated by a statistical model that objectively predicts the likelihood that you will repay on time. Banks, insurance companies, potential landlords and other lenders use credit scores.
A credit report that includes late payments, delinquencies or defaults will result in a low credit score and could mean not getting a loan or having to pay a much higher interest rate. The higher your score, the less risk you represent to the lender.
Review your credit report at least once a year to make sure all information is accurate. If you find an error, the Fair Credit Reporting Act requires credit reporting companies and those reporting information to them to correct the mistake. To start the process of fixing an error:
As you can see, a big part of building wealth is making wise choices about debt. You need to maximize assets and minimize liabilities to maximize net worth. To manage debt, you need to know how much you have and develop strategies to control it.
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Source: Federal Reserve Bank of Dallas Building Wealth, 2006. Reprinted with permission. |
