Welcome to another episode of #FinanceFriday; and as stated last week, today we will continue with Managing debt.
Last week we mentioned some of the most common debts, namely housing, vehicle, education, vacation and home furnishing. Another common one that we may not see as a loan is a credit card. We will begin with the simplest and move on from there.
Credit Cards: A credit card is a loan with flexible repayments since you as the cardholder can determine how much you pay towards it (the financial institution gives a minimum payment). Some of the benefits of credit cards include convenience, safety (you don’t have to walk around with lots of cash), cash back, travel rewards or miles programs and travel insurance. All wonderful and useful benefits. On the flip side, however, the flexibility of the repayment terms is what often gets users into trouble, because they focus on making the minimum monthly interest payment while ignoring the principal debt. Interest rates on credit cards are high and therefore only making interest payments can put you in an interest cycle. If this debt is not properly managed, within a short period, the card holder can realize that they are at the maximum card limit and the balance owed is not reducing. To manage your credit card, pay off the debt in full before the due date if possible. If this cannot be done, pay more than the minimum repayment. If you realize that the card has become a burden, stop using the card and come up with a plan to pay down the debt in full.
Vacation: While it may be nice to take a loan for a vacation so that you can enjoy the scenery of a new place and shop, is it really the best thing to take a loan for an extended period for an activity that will be over within one month? People sometimes apply for loans for $15,000.00 to travel to the USA, having to repay this debt over three years; and this is an activity that they will do annually. This means that before they even repay the debt from the previous year, they add additional debt to the existing one. This is not the best practice. Some alternatives to cover vacation expenses can include saving a specific amount monthly in order to accumulate funds for a planned trip. Joining a sou-sou and scheduling your “hand” close to the period of travel. If taking a loan is necessary, then it should be repaid within a short period (a year).
Vehicle: A vehicle is a very convenient tool, but it can also be very costly. Whether you choose to purchase a new or a used car, some things to remember include: the vehicle must be maintained, insurance and licensing fee must be paid, tires have to be purchased. It is, therefore, important to remember that one must not only consider the purchase price, but all the additional ‘frills.’ One must also consider if the interest is charged on the reducing balance or if the total interest charged is added to the amount borrowed and then the loan paid down monthly (reducing balance is usually more beneficial to the borrower). Also noteworthy is the type of insurance coverage required. Comprehensive insurance would be more costly but will cover both you and the other party in the event of an accident (generally required once a loan is taken). Third party insurance while cheaper than comprehensive will only cover the cost of repairs for the other driver and will result in you having to bear the cost to repair your own vehicle in the event you are at fault. Before deciding to purchase a vehicle, it may be best to estimate the expenses associated with your vehicle maintenance and save for it monthly/weekly (whichever is most convenient) so that you are not caught off guard when they become due. Preparation is key, don’t be caught off guard.
To avoid information overload, we will stop here today and continue next week when we will continue our discussion on managing debt, focusing on housing loans (mortgages).
See you next week! Gerlan