Through Jeané Herman, CIRP, LIT, vice-president, MNP Ltée.
Smart credit uses credit that you can afford. It’s more than having the means to pay the monthly installments. It’s being able to pay the amounts you owe in full, over a reasonable period of time. A reasonable time frame for consumer credit, such as credit cards, lines of credit, and unsecured loans, is the ability to pay off the balance owed, in full over a five-year period. For mortgages, they are often amortized over 25 years, which is reasonable.
To complicate matters further, you could have an exceptional credit rating but be completely crippled by growing debt. Your overall financial health isn’t just measured by your credit rating.
Credit is just a tool. Like any tool, if used correctly it can be useful, but if misused it can cause serious damage.
Consider the following example:
John has a credit score of 730/900. John is married and has 2 children. 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 car loan payments every month, and he pays the minimum payments on both of his credit cards. He only pays interest on his line of credit. How would you rate John’s financial health?
What if you found out that after paying off debts, paying utilities, taxes, and car expenses, she has $ 200 left for expenses, like groceries, before her next payday? Are John’s finances healthy?
John’s truck recently expired the warranty and he just found out he has a $ 1,000 repair bill for the engine. He just finished all of his payments and needs his vehicle to get to work and to the grocery store. John knows he can pay $ 300 to repair his card because he just made a $ 300 payment, he can also pay part in cash (and not do the grocery shopping this week) and he is hoping that the repair shop will let him make the payments on the remainder of the repair bill.
How healthy do you think John’s finances are now?
Having emergency savings to pay for an unexpected expense or to deal with a temporary job 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 combination of credit products (credit card, line of credit, car loan) rather than one type like a credit card (stay away for payday loans and high interest financial loans)
- Do not use all the available credit on your cards (do not go over or over the limit)
- Make your payments on time and pay more than minimum payments on credit cards and lines of credit
- Review your credit report every six months and correct any errors
- 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 off his credit cards and set aside emergency savings on a monthly basis, he would be in a much healthier financial position to take care of an emergency car repair. He would probably be less stressed too!
If you are at or near your credit limit, what if you had to get your car repaired or if your income was reduced because you got sick? Creditors will always be waiting for their payments, and it may not matter that you made payments on time each month and have a good credit rating.
You are not alone, there are professionals who can help you. Many people have found relief from MNP Ltée – Licensed Insolvency Trustees who will take the time to understand your current situation and offer you personalized solutions to meet your specific needs.