| Understanding Personal Credit |
| Far from simple, borrowing money can be a complicated process with hidden fees and expenses. How can you borrow money more cost effectively? |
| For most people, using personal credit is a very common part of financial life. While there are many potential advantages to using credit as a convenience source of funds, excessive credit use can wreak havoc on an otherwise strong financial plan. It's critical to understand how credit works and the importance of building these obligations into your personal budget. |
The Fundamentals of Personal Credit
Types of Personal Credit
Sources of Personal Credit Include
The Cost of Borrowing
Obtaining a Loan
Managing your Credit
Credit Cards
Using your Securities to Borrow
How to get started!
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 The Fundamentals of Personal Credit |
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| There are many different types of personal loans and an equal variety of lending sources. While some loans require monthly or even annual payments, other loans require a large single payment of both principal and interest. Typically lenders will ask that borrowers use certain assets as collateral to guarantee the payment of their loans. Still, there are some loans that simply require a borrower's promise of repayment. |
| Many lenders offer a full variety of loans while others specialize in very specific types of personal credit. Among these lenders, there can also be many differences in credit qualification, fees, and interest rates. |
| Types of Personal Credit |
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Installment credit includes loans that require you to repay the amount borrowed in equal periodic payments, generally monthly. Example: cars loans and high-end appliances.
Non-installment credit includes single payment loans and open-end credit.
Single payment loans require that you pay the entire amount that was borrowed on a specified date.
Open-end credit, or 'revolving credit', allows you to borrow additional funds when needed, as long as your balance doesn't exceed a predetermined limit.
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| Sources of Personal Credit Include |
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| Commercial Banks, Consumer Finance Companies, Credit Unions, Life Insurance Companies, Savings & Loan Associations, and Brokerage Firms. |
| The Cost of Borrowing |
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| With many different methods of calculating the interest rates on loans, borrowers are often confused as to the entire cost of borrowing money.
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Interest rates depend on numerous factors including:
The length of the loan,
The value and liquidity of securities pledged as collateral,
The borrower's credit history,
The price the lender must pay for the money that is being loaned
Economic activity, and
The policies and actions of the Federal Reserve.
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| Obtaining a Loan |
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Before you approach a lender, you need to make some fundamental decisions based on your specific needs:
How much money you would like to borrow
The length of time you will need the money
Your preferred method of repayment
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| Lenders also have many factors to consider before making a loan. The key variables in evaluating loan applications include: credit reports, character references, collateral, your capacity for repayment, and financial assets you own. |
| Maintained at one or more credit bureaus, your credit file contains personal information including: your name, Social Security Number, birth date, current and past addresses, current and past employers, and whether you own or rent your home. In addition, it encompasses information such as your income, checks that have been returned for insufficient funds and a detailed record of all of your credit dealings. |
| Credit professionals suggest that every three to four years, and at least six months before you apply for a large loan, you should carefully review the information in your credit files at any or all of the three national credit bureaus: Equifax, Trans Union Credit Information Company, and TRW. |
| Managing your Credit |
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| Your ability to handle credit is influenced by many of the following factors: your current and future income, your current and future expenses, the interest rate on your loan, borrowed money, the payment terms on your outstanding loans, and perhaps the most critical, your own financial discipline. |
Determining your debt limit
Many planning specialists suggest this standard measure to determine if you have taken on too much debt.
Compare the percentage of your take-home pay (disposable income) that you need to pay debts other than a home mortgage and any monthly credit card debt that is paid in full.
If your debt payment as a percentage of your disposal income is 10% or less, you're considered conservative; if the percentage is more than 20%, you've probably overextended your credit.
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Developing a personal budget
How can you ensure that you are saving and investing for the future as well as controlling your borrowing with good credit management? The key is developing a personal budget - and sticking to it! You can begin to develop a personal budget by following the simple steps below:
Estimate your income, including earnings and income from savings accounts and other investments
Estimate your investments and savings in all of your investment and bank accounts.
Estimate your expenses, both fixed and variable, for things like rent, life and auto insurance, utilities, entertainment, clothing, etc.
Project your loan payments for mortgage, auto loans, credit union, and outstanding balances on one or more credit cards.
Calculate income less investments/savings/expenses and loan payments to determine whether you could potentially experience a shortage or a surplus during a certain budgeting time period.
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| Credit Cards |
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| Why are credit cards so popular? These credit tools give you the flexibility of paying in full each month or, extending your payment by revolving the balance. You can choose to pay the minimum amount due or, any dollar amount over the required minimum. This makes it easy to manage your expenses from month to month. However, you need to keep in mind that credit card providers charge interest on unpaid card balances which can be higher relative to other secured credit tools. |
Charges to credit card holders may include the following:
Annual fees
Cash advances fees
Penalties for exceeding your credit limit
Late fees if you pay less than the required minimum
Card issuance fee for more than one card per accounts
Finance Charges and
Overlimit fees
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| Using your Securities to Borrow |
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| Brokerage firms have become a source of credit when you have deposited securities in a margin account. These assets give you the ability to borrow money for almost any reason through a secured loan, also known as a 'margin' loan. Your eligible securities serve as collateral and provide access to a low-cost credit alternative. |
| People have traditionally used margin borrowing to pay for additional investments that significantly increased their profit potential. While this is effective when the securities in your portfolio increase in value, your potential for incurring capital loss risk is greatly increased if the value of your securities decreases. |
| Under the Federal Reserve rules, you are typically allowed to borrow up to 50% of the purchase price of a listed stock, from 70%-75% for many bonds, and up to 90% for U.S. Treasuries. |
| How to get started! |
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| If you are considering borrowing money, or re-evaluating your current loan structure, first determine how much money you need, how long you will need it, and how you wish to repay it to your lender. Then you can either work directly with an appropriate lender, or, work with your Financial Advisor to review your credit needs and provide the most cost-effective borrowing options. |
Understanding Personal Credit