Managing Credit – Avoiding the Debt Trap

The information in this publication is for general purposes only. You should consult me for specific recommendations appropriate to your individual situation.

WARNING: The following danger signals may indicate that you're heading into a "debt trap" which can become impossible to escape unless you take immediate action. If some of these statements apply to you, CPAs strongly suggest that you proceed with caution.

	You charge purchases you don't really need.
	You purchase items with minimum down payments.
	You take cash advances on credit cards.
	You find yourself borrowing more and more money from family and friends.
	You use your cash reserve to pay bills.
	You postpone paying your bills.
	You receive new bills before old ones are paid.
	You reach or exceed your credit limit.

Living on credit can become a way of life. And if you are among the millions of Americans with chronic debt problems, you may need to put yourself on a debt management plan.

There is an escape

With proper planning, you can escape the "debt trap" and free yourself of financial worries. First, you'll need to know exactly where your money is going. To get an accurate picture of how you spend your money, track your spending for at least three months. Are you spending more than you need on clothing, entertainment, gifts and other luxury items? Do you charge items to console yourself when you're depressed or to reward yourself when you feel you deserve it? Once you are aware of your negative spending habits, you can revise them accordingly.

Second, you must start reducing your debt. This requires setting definable goals. For instance, decide how much debt you would like to pay off within a certain time. Then you can establish rules that will help you achieve those goals. If you consistently follow your rules, you may find yourself managing debt more efficiently. Here are some practical guidelines for using credit.

· Use credit as a last resort. Don't get in over your head by committing yourself too casually.

· Think your purchases through. Many expensive purchases are made impulsively. Resolve to spend money only according to your plan. Pay back what you owe now. Don't take on more debt until you pay what you already owe.

· Don't borrow to pay off other debts. This method usually fails and you may end up increasing your debt.

· Leave yourself a margin of safety. If more than 15 percent of your after-tax income is going to credit payments, be firm about following a debt management program.

Don't look for any relief on your tax return. As of January 1, 1991, interest on personal debt is no longer deductible.

Using credit wisely

In certain situations, credit is necessary and, if properly controlled, it can help you achieve financial freedom. For instance, buying a home and paying off a mortgage allows you to build home equity. As long as you're following a budget, and you can afford to make the monthly mortgage payments, it will usually pay off in the long run. When you borrow money to increase the value of your assets, you are using credit wisely.

There are also advantages to owning a credit card. For instance, you don't have to carry large amounts of cash, or pass up a good deal because you're short of cash. And if you establish a sound credit history, you may find it much easier to secure a mortgage. For these reasons, it is important that you establish credit and manage it carefully.

Controlling your credit card

Having a credit card is a great convenience. However, it is crucial that you control the card and not the other way around. If you can't use your card wisely, you may have to cancel your account and throw the card away. You must also understand the terms of your card and the way it works. Besides annual percentage rates (APR), annual fees, and grace periods, you should be aware of the method the credit card company uses to calculate interest.

· Adjusted balance. The interest charged is based on the amount you owe after subtracting your payment from the previous balance. This method is the least expensive one.

· Previous balance. This method is the most costly since you receive no credit for payments made during the billing period. Instead, you are charged interest on your balance at the end of the previous month.

· Average daily balance. Your balances for each day in the billing period are added. The total is then divided by the number of days in the billing period.

Once you know the terms of the card, you can select one that suits your needs. For instance, if you consistently carry a balance on your card, choose one with a low interest rate. If you pay your balance in full every month, select one with a low annual fee. Be aware of cards that charge unreasonable late payment fees, high cash-advance charges, and over-limit penalties.

One word of advice to those who pay only the minimum amount on monthly payments - don't. The longer it takes for you to pay off the bill, the more interest you'll be paying. You may very well end up paying more in finance charges than the item you purchased is worth.

Check your credit report

Before they grant you credit, potential lenders will check your credit report. If the report contains anything negative, your application will probably be rejected. Even if you're not planning to apply for a bank loan or a credit card, derogatory information could prevent you from getting a house or even a job, and that information stays in your file for as long as seven years. Make sure you request a copy of your credit report periodically and check it for errors.

Financial freedom at last

Though financial freedom may seem far off, there is a way out of the "debt trap." First, you must understand how credit works and how it should be used. Then, develop a workable plan, establish your own rules for using credit and follow them faithfully. If you need help developing a structured debt management plan, contact a professional financial adviser, such as a CPA.

Protect yourself against credit card fraud

Credit card fraud is more common than you may think. Someone can easily obtain your credit card number, duplicate your card, and use it to purchase items or withdraw cash advances. Here are some measures you can take to avoid credit card theft and fraud.

· Ask for your carbon copies and tear them up so no one can duplicate the card.

· Keep an eye on your card when you give it to salespeople to see that they don't run it through the machine twice. Make sure that the card returned to you is your card.

· Never give your card number to anyone on the phone unless you initiated the call.

· Examine your monthly bill carefully. Compare your receipts to the bill. If there is a mistake or you cannot account for a charge, report it promptly to the card issuer.

· If your card is stolen, notify the issuer immediately. Most card issuers have toll-free numbers for this purpose. Keep a well-hidden list of all your credit card numbers, issuer names, and toll-free numbers, so that you can take immediate action if your cards are lost or stolen.

· Federal law limits your liability for unauthorized charges to $50 per credit card. But you don't have to pay any charges made after notifying card companies of your loss. After calling, follow up with a telegram or registered letter.

· Don't leave your card where someone else may find it. You should also cancel accounts for cards you don't need or use.

· It is illegal for anyone to send you an unsolicited credit card in the mail. If you do get one, and don't want to use it, feel free to destroy it.