Using Credit Is Okay Sometimes

Tip #288 - Using Credit is Okay Sometimes. I'm going to say something on here that I don't see on many personal finance blogs. I have read dozens of personal finance and money-saving blogs over the past few years. And the almost universal theme I see in all of them is that the writer started his blog because he racked up a lot of debt and learned how to dig himself out and wants to pass his experience and advice on to others. Sometimes this advice is in the form of "Throw away all of your credit cards," "Live a debt-free life," or "Wait until you have the money set aside before you buy what you want." In fact even Dave Ramsey got started down his successful career because he was in a lot of debt at one time and pulled himself out of it.

Now here's my comparison to that line of thinking. If you are an alcoholic and want to stop drinking, then looking to alcoholics who have given up alcohol and have been living a sober life for years is a great place to start. And like alcoholics, people who have absolutely no willpower when it comes to going on a shopping spree with their credit card and no money in the bank to pay back the bill in 30 days when it comes due, that advice most personal bloggers give is probably sound.

But what if you were never an alcoholic? What if you hardly ever drink or just like a glass of wine with your meal once in awhile? Whose advice do you look for so that you won't become an alcoholic? The answer? Probably no one's. Why would you be looking at a reformed alcoholic for drinking advice since you don't abuse alcohol? Now substitute alcohol for credit cards. If you aren't out-of control with them - if you use them to make big-item purchases or to go away on vacation, why is that bad for you? It's not always. There are plenty of people out there who are just not educated in finance who just want to figure out how to best build up their savings, how to spend less, or how to invest. To those people, I say, it is okay to have credit cards. It's okay to take out a loan if you need one. It's okay to float your money for a month to earn interest - as long as you have a financial plan and a budget, and are living within your means.

Let's look at some scenarios of when using credit is okay or not okay:

Example 1: Marnie has a budget and a financial plan. One of her goals has been to buy a car. She's been saving money for 5 years for it and has $10,000 in a CD earmarked for the car. The CD is earning 6% interest, and it is coming due in 6 months at which time she will buy her car. But her car dies suddenly and she needs to buy one this week instead of 6 months from now. She can get a loan from her credit union for 4.5% interest, and she can pay it back in 6 months when her CD comes due. Should she take out a loan? Many people tell her she should never take out a loan on a decreasing asset. But if she breaks her CD, she will lose her interest. Besides, she is borrowing at a lower rate than what she is earning. Is using credit okay in this situation? My advice? Take out the loan. Marnie's story shows she is responsible with money. She has been saving long-term for a goal, and she has a budget and a plan. When her CD comes due, she can pay back the loan and all is good. If the interest she is making is greater than the loan she is taking, then by all means she should take the loan.

Example 2: Mindy has $12,000 on her credit card balance. She pays the minimum $250 each month on the card. Her dad told her, it will take her 15 years to pay off her balance by just paying the minimum, but she doesn't care. She thinks as long as she can pay the minimum she is in good shape. Plus she tells herself that she always has $350 leftover each month that she can put toward the card, but she chooses to only put the minimum amount towards it and spend the remaining $100 on a night out.

Mindy's friends call her and tell her they have found a fabulous deal on a cruise - 6 days in the sunny Caribbean for just $800. Mindy knows that she can afford it because even if it makes her minimum payment higher on her card, she can still pay it and forgo going out to dinner each month. Is using her credit card wise in this situation? I think all of us would probably agree here that Mindy is not responsible with money. She might, in fact, be termed a crediholic. She cannot give up using her credit card and has no understanding of how little she is paying back when just paying the minimums. My advice? No way! Have someone sit down with you and work on a plan to accelerate your credit card repayment instead and explain how credit cards work.

Example 3: Craig is 35 and single. He has $350,000 saved toward retirement and puts away $20,000 more per year towards it. He also has 6 months' worth of money in the bank in case of an emergency and two savings accounts set up - one for for a car and one for a house. He should meet his car goal next year, and his house goal in three years. His take-home pay is $7,000 per month and he uses his credit card buy all of his items - his groceries, clothes, vacations. He pays off his balance each month. Lately, Craig has been reading personal finance blogs and most of them say that credit cards are bad. He wonders if he should get rid of his cards and start paying cash from now on. What do you think? My advice? No. He sounds like he is set for retirement, his car, and his house. Sure, he may spend more money in the grocery store for an impulse buy that he might not do if he paid with cash. But he can limit is losses with credit cards and they give him some insurance if he uses it for air travel or car rental. And for big purchases, as long as he is deciding on how much to spend before he buys, then using credit is a better deal. It not only gives him some refund power if there is something wrong with the product, but it also gives him 1% reward with each purchase. As long as his financial plan is sound, then he does not need to live like a pauper - giving into an occasional carton of ice cream at the grocery store will only help him enjoy life more.

I can give many more examples where I think it's okay to use credit cards or take loans. Conversely, I can think of several examples, and know many in person who need to stay clear of debt of any kind. Which type of person are you?. Are you a crediholic? Can you not control yourself if you have a credit card in your hand? Do you like to buy things "above your means" such as a fancy sports car and put it on a loan? If so, give them up and follow what many financial bloggers are saying about credit cards or debt. On the other hand, are you responsible with your money? Do you have a savings account? An emergency fund? A financial plan for the future? Do you take out a loan only when you know you are doing it for the right reasons and can pay it back in a reasonable amount of time? Do you decide in advance what you will buy and then happen to pay for it with a credit card? If so, then it's okay to use credit and take out a loan. Just like an alcoholic, crediholics should stay away from debt and credit cards. But just like there are millions of others out there who can control their drinking, there are many who can use credit and debt wisely, too.

In Real Life (IRL) - Our credit union has a great deal on IRAs. From January until April you can add more money to any existing IRA CDs. For example, I have some IRA CDs. One of them is earning 4.9%. I opened it a few years ago and there are still 5 years left until maturity. If I were to put my $5000 Roth money that I invest each year into a current IRA at this credit union (or anywhere else for that matter), I'd be able to earn 2.6% for a five-year certificate. On the other hand, during January to April, I can add on to a current IRA that I already have such as the one earning 4.9%. I love this deal and only found out about it last year.

I've always wondered how much longer they will continue to offer this deal. Last year I made 2009 IRA contributions in early 2010. But this year, I started to think about whether they would even continue this deal next year and decided I wanted to make all of my and my husband's 2011 IRA contributions now while I know they still have this offer. Problem was, I didn't have the money available for it. Sure, I knew by year-end, we'd have the $10,000 saved up to put toward our IRA. But in April? We only had $3,000 of it saved. So what did I do? I took a loan. Yes, I did. We have a home equity line of credit for $50,000. We owed nothing on it so it was available, and current rates are 3.25%. So I borrowed $7000 from it with plans to pay it all back this year with the money we would have put toward the IRA.

Did I do the right thing? I think so. I'm currently making more in the IRA (4.9%)than I am paying out on the Home Equity Loan (3.25%). Yes, the home equity loan rate can change but it would have to go above 5% for it to cost more than I'm earning on the IRA since the interest is tax deductible. Also, I am getting the gift of time. Even if the bank continues this great IRA add-on offer, I would have to wait to put the money in the IRA until January 2012, and I will have lost out on 9 months' worth of interest, while the money sits in a checking account waiting to be invested. So I am earning about $262 in those 9 months and paying out about $170 (before a tax deduction) if I keep the loan for the whole 9 months. Plus I am assured of getting this great deal from the credit union that might not be available next year.

Had I said to my husband "Let's go take the trip around the world we've been wanting to take and just use our equity fund, I would not think taking a loan in that instance is wise. Each situation and each person is different - sometimes it's wise to use credit. Other times it's not. What do you think? Do you think having some debt or using credit cards and taking out loans is okay?

Please check out other financial ideas on Frugal Fridays at Life As Mom.

Be Careful About Saying "What's Another $1,000?"

Tip #264 - Be Careful About Saying, "What's another $1,000?" I know there are many people out there drowning in debt. Not including a house mortgage, I have read many people's stories about owing others $20,000, $40,000, $70,000, or even over $100,000. This might be a combination of student loans, medical debt, credit card debt, and car loans. And when one has $65,000 in loans, it is very tempting to say, "What's another $1,000? Let's go buy that large screen television."

Please, please, please don't think this way. Another $1,000 is another $1,000. And while it may seem like a drop in the bucket when you owe $50,000 or more. It's not - it's $1000 plus interest over time. When you seem like you are drowning in debt, don't keep adding to your debt because you think it's just another small drop in the bucket. Instead, work out a plan to attack the debt that you already have.

On the positive side, I've also read many stories where people have said they have paid off $35,000 in debt in two years or $70,000 debt in five years. So it can be done. Instead of adding to your debt because the amount seems insurmountable anyway, make a plan to get out of debt. Write up a financial plan for the next five years, create a budget, find ways to reduce your expenses and/or increase your income, and start paying that debt down. Every dollar of debt does count. Even if the number seems extremely high and too much to conquer, do not feel helpless and keep adding to that debt. It will only make the number that much higher when you decide enough debt is enough. So take wherever you are at today and start to tackle it. Don't throw in the towel.

In Real Life (IRL) - Several years ago I went to see a well-known designer, Michael Payne from HGTV, give a talk at a Home Show. As he was telling us about remodeling, he said the four most dangerous words when doing a room or house remodel are "While we're at it..." The audience had a giggle about that, but this phrase has always stuck with me. When redoing a room or a house for tens or hundreds of thousands of dollars, it's easy to say, "While we're at it, let's do the bathroom for another $10,000: or "Let's add a deck for $15,000," because after all, if you are already spending $100,000 on a remodel what's another $15,000? Well, it's another $15,000, that's what it is - not too different from ther person who feels overwhelmed with his debt so he keeps on spending. It's a very dangerous place to be.

I have a friend whose husband is out of work. This family has always lived pretty well - and I suspect above their means. So when the husband lost his job, I thought they would finally cut back on their spending. Instead, I see no change in their lifestyle. They recently confided in me that they spent $3,000 to send their son to summer camp. I was aghast - literally. After all, who spends that kind of money when they clearly do not have it? And that's when the idea for this post occured to me. I suspect that they have so much debt that another $3,000 just doesn't seem to mean much to them anymore. After all, what is $3,000 when they maybe owe $60,000 or even $150,000? I can't say much to her; I have tried. The best I can do is be an example.

My husband is not even out of a job, but as I mentioned in an earlier post he was told that his office will be closing in about 18 months. And because of that, I have already cut back. I cut out a $125 camp that I didn't feel was necessary this summer. And I have continued to show my friend the benefits of thrift store shopping. But she doesn't catch on or isn't interested. So I keep my mouth shut. And instead I write on here anonymously so maybe others can build up their financial knowledge and make wise choices with their money. And while you're at it...save some money up, as well. For other ideas on saving money, check out Frugal Friday.

Don't Dig Yourself Deeper Into Debt - Part 3

Tip #168 - Don’t Dig Yourself Deeper Into Debt – Part 3. In Parts 1 and 2 of this series we discussed how to get out of consumer debt. In this last part of the series we will discuss how to stay out of debt.

After you have come up with an amount you need to pay off each month and have adjusted your expenses so that you can meet that payment (or increased your income to make that payment), then the final step is staying out of debt. By making a budget that lists all of your income and all of your outgo, you can stop spending more than you earn. But you need to strictly follow the budget to stay within your means. If your income is $5000 per month, then your expenses need to stay under that amount to stay out of debt. Simple in theory, but harder in practice. So let’s look at specific methods of staying out of debt.

The first step to staying out of debt is to not spend money before you earn it. Some people spend money before they get it because they know it’s going to come in their paycheck next week or next month. Well, let’s try to get out of that habit. Scrimp and save for a week or two or a month until you are all caught up with your paychecks, so that you are not spending in advance of earning the money. Once you are caught up, stick to your budget and don’t spend the money unless you already have it. It will take many sacrifices but once you are on the right spending cycle with your income, it will be much easier to live within your means.

The other step to staying out of debt is to not spend more than you have by not using your credit cards. Using credit cards allows you to spend money that you don’t have. If you just stick to money that you have in the bank and in your pocket, then you cannot go into debt. All of this sounds ridiculously simple, and while the concept of it is, the reality isn’t always so. A car breaks down and there is no money to pay to fix it, so you put it on your credit card. Or a special occasion comes up and you decide to front the money until you get paid the following week. As I said, it’s not easy. It takes a lot of discipline, hard work, and a realistic budget. That includes a line item in your budget for car repairs and a line item for special occasions. If you have an old clunker car, then you need a line item in your budget for repairs. Otherwise the budget isn’t realistic. If you have no money left in your budget for this line item, then you need to cut out a luxury in your life – the cable t.v. or the new clothes you like to buy. Again, it sounds simple on paper, but is harder to do in real life. However, in order to keep your outgo less than your income, you need to be prepared for things that come up and include them in your budget. This way you are not putting things on your credit card that you haven’t budgeted for.

In summary, to get out of debt, address your problem, figure out a payment plan to pay the debts back by increasing your income or adjusting your budget. If you don’t have a budget, make one, and make sure it’s realistic to meet your needs. Once you are following these steps and have gotten out of debt, you need to stay out of debt. Don’t spend money before you earn it and don’t ever spend money that you don’t have. Once you follow these steps, you will get used to your new way of life and you will wonder how you ever lived in debt before. You will feel freer and happier, and will probably sleep better at night, too.

In Real Life (IRL) – As with every thing else, once you address your problem that you are in debt, you are halfway there to solving the problem. I always read about people who follow Dave Ramsey to get out of debt. Out of curiosity I read his book and understand his appeal. He outlines about 7 steps to getting out of debt. It’s not a magic cure or anything truly out of the ordinary. It takes hard work, budgeting, and being committed to paying off your debt on a schedule.

While reading finance blogs and forums, I have read about many people who have paid off their debt using Dave Ramsey or similar plans, and I’m talking thousands and thousands of dollars’ worth of debt. That takes incredible discipline and a change of spending habits. Anyone who can do that has my admiration. It’s hard work to be sure. But the results are so worth it. Once you are out of debt and are living within your income, you can really start to live. You can go to sleep well at night knowing how your bills will be paid on time. Also, you can spend your money contentedly knowing that you can afford what you are paying for. It's not easy and I wish everyone who is in debt or whose spending is out of control the best of luck in taking the first step to taking care of it.

Don't Dig Yourself Deeper Into Debt - Part 2

Tip #167 - Don’t Dig Yourself Deeper Into Debt – Part 2. In Part 1 of this series we discussed how to start getting out of consumer debt. In this part of the series we will discuss how to completely get out of debt.

After you have come up with an amount you need to pay off each month (in our example we came up with $333 per month), you must figure out where this $333 is going to come from. This is the harder part. Again, if this debt you are paying back is from a time when you were spending more than you earned (but you aren’t spending more than you earn any more) or from a one-time event in your life then you are in a better position than someone who is currently living above their means. If the debt is from one of the first scenarios, you have two choices – cut down your current expenses or earn more money. If you can get a second job paying $333 per month, then great. Your work towards paying back your debt is pretty much done. (Although there is still more work to do to stay out of debt.)

If you can’t bring in any more income, then you need to cut down on your expenses. Cutting down your expenses means writing up a realistic budget (or a list of your current expenses/spending habits) to see where your money is going. And then you must evaluate what you can cut to make up the $333 per month to pay back. Hopefully, you can find easy ways to cut back to save up that money. Cutting back on cable and trips to the beach for a few years might be enough to cover your debt. Or maybe you need to do something more drastic like finding an apartment with lower rent.

Many people at this point might say that they cannot cut their expenses any more than they already have. I don’t believe this. There is room in almost anyone’s budget to cut expenses. Cut it down to basic needs only if you have to. Getting out of debt should be your top priority. Drink only water; don’t buy new clothes; cut your own hair: or carpool to work. All of these types of things cut expenses out of your budget. And if you truly have no other expenses to cut then go back to the first option, which is to bring in more income. Those are your only choices or you will never be able to pay back your debt.

Now, if your debt was not a one-time occurrence or the result of frivolous spending when you were younger, then you are on your way to being debt free and building up financial security. But if the debt you are paying back is still accumulating because your expenses (or outgo) are greater than your income, then you are still accumulating debt even as you are paying back your old debt. And if that is your case, then you will never pull yourself out of the hole you are digging.

This is why a making a monthly budget is vitally important. You must list out all of your expenses in all of your categories of spending. If the total amount of monthly expenses is greater than your monthly income, then you need to cut down your expense until they are equal or less than your income. And that means including a category for your monthly debt repayment. Again, you figured out back in the goals section of this exercise the amount of debt you needed to pay back on a monthly basis (in our example $333). Figure it out so that it is a reasonable amount that you can afford to pay. And try to do it in the shortest timeline possible so that the goal is attainable (about 5 years or less). Any longer, and the goal starts to seem out of reach, and you will lose interest. Once the full debt is paid back, that money can become your savings. In the last part of this series we will discuss staying out of debt.

In Real Life (IRL) – I mentioned in my first post that I was recently thinking about debt repayment because some people I know who I believe are in debt seem to continue on their wild spending spree. Impromptu vacations, costly clothes, and dinners out seem to be the norm in their everyday expenses. I cringe when I hear them talk about all of the things they are doing, because I am fairly certain they don’t have the money for it, let alone that they already owe money to credit card companies. I think it’s so easy to spin out of control in this regard. Once people already owe a few thousand dollars, what’s a few more dollars for Chinese takeout or a couple hundred dollars for a hotel?

The problem is besides that they are adding to their debt, they are not facing their problem, which is a continual cycle of spending more than they are bringing in. Over time the debts get larger until there is no end in sight to pay it back. Facing reality and suddenly living on less isn’t appealing. But at some point they either need to address the problem or they may need to declare bankruptcy, which should really be the last resort. They really need to figure out a debt repayment plan and then cut back on their expenses or they will never dig their way out of the debt they have created.

Don't Dig Yourself Deeper Into Debt - Part 1

Tip #166 - Don’t Dig Yourself Deeper Into Debt – Part 1. Getting out of debt is not a forte of mine for, fortunately, good reason. I have never been in debt. Well, I have a mortgage on my home that we’ve always been able to handle, and if push came to shove, I could pay it off if I had to. What I mean though is that I’ve never been in credit card debt, student loan debt, or any type of consumer debt. So I have no 5-point plan or 7-point plan for people to get out of debt. But I do have friends and family members who I believe are in debt and I wish I could offer help or advice to those in that situation. But talking about money to people I know in real life is a bit of a challenge. Most people who are in debt don’t advertise it, and many who are in debt don’t really want to hear what others think they should do about it. But I’ve been thinking about it a lot lately, so I figured I would at least write my thoughts here and maybe help someone I don’t know.

Once you are in debt, don’t dig yourself deeper into it because you don’t think you can pull your way out of it. If you are $50,000 in debt, don’t run out and spend another $10,000 because it’s just a bit more debt. That’s like a person who is 50 pounds overweight thinking it’s okay to eat more, because what’s a few more pounds? Well, truly, it’s a few more pounds you need to get rid of when you decide you are too fat. Just like $10,000 is extra money you need to pay back when you decide you need to take control of your finances.

Before you do anything, take a realistic look at your spending habits and figure out why you are in debt. If the debt is being carried over from a foolish point in your life when you were spending more than you earned, but you are not anymore or if it was from a single event in your past like paying for college or a big medical bill, then you are not in too bad of shape. But if you are still spending more than you earn, then there is a lot more work to be done.

In either case, write out a plan of attack to pay back your debt. Paying back $20,000 or $50,000 isn’t going to be easy. That’s for sure. But it’s not impossible. Either of those amounts sounds overwhelming. So break down the amount into smaller amounts so that your goal is attainable. Paying back $20,000 can be done easily in about five years by packing back $4,000 (plus any interest accruals) per year. Does paying back $4,000 seem attainable to you? If not, break it down even further. How much does that work out to per month? About $333. Now that sounds like a manageable amount. Now you have a plan of attack. You plan to pay off your debt of about $20,000 by paying it off in about five years by paying back $333 per month. In the second part of this series, we’ll talk about how to get that $333 and how to stay out of debt.

In Real Life (IRL) – The reason I’ve been thinking about debt a lot lately is because I have my suspicions that someone I know is deeply in debt because of some expensive spending habits and some bad times with the current economy. And I suspect these people aren’t alone in this situation. What gives me great pain, however, is to see these people continually spend money as if they are in no financial trouble at all.

My family who is in decent financial shape doesn’t spend money on such luxuries that these people allow themselves. And that bothers me. Not because I am not living the good life (I am quite happy with my expenses), but because people I care about are living beyond their means. Whatever debt they may have already been in, they are continually adding to it as if just a little bit more won’t matter. I’d love to sit them down and ask them to write up a plan to pay back their debt and then ask them to write up a reasonable budget to live on. But I can’t, because it’s not my business. They are grown adults who make their own choices. I try to be a good example to them but it seems not to make a difference. So I struggle with my choice not to say anything to people who I think are figuratively drowning in debt. I’ll talk more about it in the second part of this series when we discuss how to come up with the money to pay back your debt.