Downsides of Credit. Personal Finance

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Table of Contents

Introduction
Actions Needed to Build a Good Credit Reputation
Signs of Overindebtedness
Common Fees assessed on Credit Card Accounts
Bankruptcy
Financial Math
Reference

Introduction

The main downside of credit is that the use of credit decreases the financial stability of an individual. With an excessive credit the individual may have to spend a major part of his/her income in repaying the amounts borrowed. This will limit the priorities that he/she can attribute to his/her limited income. Secondly, it is expensive to avail credit with higher amount of interest payable on the amounts borrowed and it also leads to get a tendency to spend over and above the means of repayment which is financially imprudent.

Actions Needed to Build a Good Credit Reputation

An individual should protect the credit reputation in the same way as he safeguards his personal reputation.

It is wise to obtain credit bureau reports every year and challenge all errors and omissions found in them in order to maintain a good credit reputation.

It also helps maintaining the credit reputation to obtain lowest APRs possible and in case of some difficulty in meeting the higher finance costs, the credit card balances can be transferred to lower-cost accounts.

Payment on credit cards should be made each month without fail. It is also not advisable to make some convenient purchases on a credit card where the individual is already carrying a balance. Checking the monthly billing statements for accuracy and challenging all discrepancies would also help to build a good credit reputation.

Signs of Overindebtedness

There are different signs of overindebtedness. The situation where one is not able to estimate the amount repayable by him/her or running out of means to settle the debts show a position of overindebtedness. Similarly paying only the minimum amount due on credit cards and continuously requesting issue of new credit cards or enhancing the credit limits are also signs of overindebtedness. This situation also results in making late payments or skipping payment of amounts due.

Common Fees assessed on Credit Card Accounts

The following are the fees that are commonly found charged for credit card accounts.

Monthly fee – when the other different types of charged to credit cards does not total to a certain minimum, this fee is charged on a monthly basis. This fee is generally found charged to accounts which are low in value.
Transaction fee – a flat rate fee is charged in respect of each transaction entered into by the cardholder. Credit card companies determine the fee based on the method of transaction.
Setup fee – The credit card companies charge a fixed sum of amount as setup fee in respect of each credit card account the companies create. This is a onetime fee payable by an individual. Chargeback fees – the credit card holder is obligated to pay this fee for the reversal of any transaction. The fee is assessed irrespective of the fact whether the reversal was carried out or not.

Bankruptcy

Bankruptcy is the right guaranteed by the constitution which permits people to make a petition to a court for declaring them officially as unable to meet their financial obligations. Bankruptcy is a situation which affects a person’s personal confidence and can also make the individual unfit to recover his credit reputation. Since a situation of bankruptcy arises because of sudden happenings like unemployment, illness, disability, death in the family or small business failures, most of the time the person does not have an alternative except to meet with the exigency of applying for bankruptcy. Bankruptcy is justified when the person has exhausted all means of financial arrangements including rescheduling of debt repayments and debt consolidations. Where there are possibilities of working out some definite arrangements with the creditors by rescheduling the loans or consolidating them bankruptcy is not justified.

Financial Math

What is the amount of their monthly payment if they borrow for four years?

Monthly payment = Loan Amount * Monthly payment at APR 16% for 48 months 2.8 * 28.34 = $ 79.35

What are the total finance charges over that four- year period?

Total Repayment = Monthly payment * No of monthly payments = $ 79.35 * 48 = $ 3808.80

Finance Charges = Total Repayment – Amount Borrowed = $ 3808.80 – $ 2800.00 = $ 1008.80

How would the payment change if Kimberly and Rebecca reduced the loan term to three years?

Monthly payment =Loan Amount * Monthly payment at APR 16% for 36 months 2.8 * 35.16 = $ 98.44

How would the payment change if they could afford a down payment of $500 with four years of financing?

Loan Amount = Cost – Down payment = $ 2800 – $ 500 = $ 2300

Monthly payment =Loan Amount * Monthly payment at APR 16% for 36 months 2.3 * 28.34= $ 65.18

Reference

E Thomas Garman & Raymond E Forgue ‘Personal Finance’ Ninth Edition.

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