By Jeané Herman, CIRP, LIT, Vice-President, MNP Ltd.
Smart credit is using credit that you can afford. It is more than just being able to afford the monthly payments. It is being able to afford to pay the amounts you owe in full, over a reasonable amount of time. A reasonable amount of time for consumer credit, such as credit cards, lines of credit, and unsecured loans, is the ability to pay the balance owing, due in full over a five-year period. For mortgages these are often amortized over 25 years, which is reasonable.
To further complicate things, you could have a stellar credit rating but be completely paralyzed by mounting debt. Your overall financial health is not measured by your credit rating alone.
Credit is just a tool. Like any tool, if used properly, it can be helpful, but if used improperly it can cause serious damage.
Take the following example:
John has a credit score of 730/900. John is married with 2 kids. John has two credit cards, a line of credit, a car loan and a mortgage. John never misses a payment on his debts. He pays his mortgage and vehicle loan payments every month and he is paying the minimum payments on his two credit cards. He pays interest only on his line of credit.How would you rate John’s financial health?
What if you found out that after making his payments on his debts, paying his utilities and taxes and vehicle expense John has $200 left for expenses, like groceries, before his next payday? How healthy are John’s finances?
The warranty recently ran out on John’s truck and he just found out he has $1,000 repair bill for the engine. He just finished making all his payments and needs his vehicle to get to work, and to go to the grocery store. John knows that he can pay $300 of the repair on his card because he just made a $300 payment, he can also can pay part with cash (and not get groceries this week) and he is hoping the repair shop will let him make payments on the remainder of the repair bill.
Now how healthy do you think John’s finances are now?
Having emergency savings to pay for an unexpected expense or ride a temporary employment setback without relying on credit is a much better indicator of financial health.
Smart use of credit
- Take stock and determine your credit needs
- Don’t apply for credit from multiple lenders (you only need one credit card)
- Use a mix of credit products (credit card, line of credit, car loan) rather than one type such as a credit card (stay away for payday loans and high interest finance loans)
- Don’t use all the available credit on your cards (don’t max out or exceed the limit)
- Make payments on time, and pay more than the minimum payments on credit cards and lines of credit
- Review your credit report every six months and fix any errors
- Set a budget, include debt repayment and emergency savings as budget items
In the example above John appeared to have good credit, but not smart credit. If John had paid down his credit cards and set aside emergency savings on a monthly basis, he would be in a much healthier financial position to handle an emergency car repair. He would probably be less stressed too!
If you are at, or near your credit limit, what would happen to you if you had to get your car fixed, or your income is cut because you get sick? The creditors are still going to expect their payments, and the fact that you have made payments on time every month and have a good credit rating may be irrelevant.
You are not alone, there are professionals who can help.Many people have found relief through MNP Ltd. – Licensed Insolvency Trustees who will take the time to understand your current situation and provide personalized solutions to meet your exact needs.