Consumer Credit

Avoiding Debt

We all strive to have good credit and avoid debt. It can be hard to meet those goals on an ongoing basis. The following common-sense principles of financial management will help you maintain good credit and guard against debt.

This is a well-known cliché, but it's true nonetheless. Returning students often have difficulty adjusting to the loss of income from full-time jobs. Some students resort to credit cards to make up for support they no longer receive from their parents. Remember that it's impossible to get into debt if you do not spend more than you have saved and earned.

Effective budgeting doesn’t mean you can’t spend any money on yourself, just as being on a diet doesn't mean you can’t eat. A budget does the following:

  • Lets you see where your money is coming from and where it needs to go.
  • Makes you aware of the bills you can’t ignore (rent, utilities, tuition, car payments, etc.) without immediate negative consequences.
  • Helps you plan for longer-term goals, such as buying a car or taking a vacation.

Once you know how much money needs to go for essentials, it becomes easier to determine how much discretionary income is available to save or spend. Sometimes this process forces you to confront difficult realities. For example, you might realize that you can’t afford to keep your car in operation and need to sell it or put it in storage.

Having a budget also allows you to talk more knowledgeably to creditors if you do experience payment problems. A creditor who has no communication with a debtor will assume the worst and more quickly resort to standard collection practices.

Many of the worst decisions that affect credit are purchases made on impulse. Impulse doesn’t distinguish want from need, or worry whether the goods or services purchased are overpriced or of inferior quality. The bigger the purchase, the more time and thought should be put into the decision to buy or not to buy.

Comparison shopping allows you to find the best price and gives you time to reflect on whether you really need or can afford the item you’re considering buying. You can use many websites and printed consumer guides to comparison shop before you visit a store.

Some people mistakenly believe that the law guarantees the buyer a grace period to cancel a purchase after completing a transaction. This is not true. The only exception is the circumstance where an unsolicited salesperson comes to your door, in which case you have 72 hours to cancel the sale, measured from the time you were given notice of the right to cancel.

Many stores have lenient return practices, but this is policy created from a desire to develop customer loyalty, not a legal duty. It's a different matter if the goods are defective or aren't fit for the purpose you intended. For example, you buy a lock mechanism which the salesperson assures you will fit your door, but it doesn’t. In these circumstances, you have a right to return the merchandise and receive a refund. The legal principles involved are the warranty of merchantability and the warranty of fitness for a particular purpose.

You can’t budget if you don’t know how much you already owe. There are many planners and other aids available to help you keep track of your bills and avoid late charges and other penalties. Authorizing automatic deductions from your paycheck can be a relatively painless way of ensuring that essential bills are paid on time, but watch out for internet, cell phone, cable and other companies who are hard to contact when you want to cancel your service or check the status of your account.

It's hard enough for college students with limited earnings to manage their own finances, much less assume responsibility for someone else’s debt. Examples of dangerous decisions include lending large sums of money to friends, buying multiple cell phones for use by family members, covering a roommate’s rent or share of utilities for a long period of time, creating a joint checking account with your boyfriend or girlfriend, or authorizing use of your credit card by someone else.

If you decide to lend money this way, make sure you have the other person sign a written statement acknowledging his or her debt to you and promising to repay you according to a specified plan agreed to by both parties.

You can become indebted by driving without insurance. Driving without insurance is a violation of the Illinois Mandatory Insurance Law, which subjects you to a mandatory $500 fine and a two-month suspension of your driving privileges, if convicted. It also requires you to purchase very expensive insurance, called SR-22, to avoid having your driving privileges suspended.

The consequences are even worse if you get into an accident and don’t have insurance. You can be held liable for the other party’s damages if you caused the accident, and you may not be reimbursed for damages to your vehicle, even if the other party is at fault (for example, if the other driver doesn’t have insurance either). You're also subject to having your driving privileges suspended for two years or longer if the secretary of state concludes there is evidence you caused the accident.

Liability insurance covers damages you cause to the other driver and is mandatory in Illinois. Comprehensive insurance covers damages to your car. It's not mandatory under Illinois law but is highly recommended, since it protects your investment.

If you can't afford automobile insurance, you probably don't have sufficient income to afford a car.

Having medical and/or auto insurance doesn’t help much if you fail to make a claim when you are sick or injured. Failure to submit a claim promptly makes it more likely you'll get contacted persistently regarding the bill and, at worst, can jeopardize your ability to be reimbursed. Always start a file and keep a copy of all pertinent bills, correspondence, requests for information, diagnoses, claims adjusters' estimates, etc. This will guarantee you have the information you need to ensure your claim is processed in a timely fashion.

You can be nitpicked into debt. Most creditors you do business with will enforce some sort of penalty for late payments. Banks do this, as well as mortgage companies, auto financing companies, landlords and even libraries.

Other creditors simply assess interest charges on unpaid balances. These compound, meaning the interest due is added to the principal. This makes for a higher principal the next month and consequently, more interest due. It's not uncommon for a debt of $1,200 to a credit card company to become a debt of $1,500 or $1,600 a year later, based solely on ongoing interest charges.

Bank overdrafts take an even quicker toll and subject you to double penalties, one imposed by the merchant where the check bounced and the other by your bank for writing the overdraft.

Writing checks without balancing your checkbook is like driving a car blindfolded: you don’t know when you’re going to crash, but it’s almost certain you will. Of course, you can’t pay your bills if you don’t keep track of them. Get a container such as a drawer, bin or folder to keep your bills together until payday.

It’s a good idea to establish a routine for paying your bills, such as paying them the same day every month. This will help get you into the habit of reviewing your bills for accuracy. It also allows you to reconsider contractual relationships which may not serve your needs anymore, such as membership in an athletic club you no longer attend or subscriptions to magazines you no longer read. In many instances, you won't be able to cancel the contract immediately, but there are often provisions that allow you to shorten the period left on your contract.

Debt often arises or worsens because the debtor is not being paid monies owed to them by someone else. This could be an employer who never paid you your last week’s wages, a landlord who didn’t return your security deposit, or a friend who hasn’t paid you back for monies you lent him or her.

Remember, debt is a matter of cash flow. If someone owes you money, find out what legal recourse is available to you to help you get your money.

The Truth About Credit Cards

Credit card companies aggressively pursue college students. Under regular credit criteria, many students would be denied a card because they have no credit history and little or no income. Sallie Mae, the student loan agency, found that more than 75 percent of college students have credit cards.

Half of all college students with credit cards don’t pay their balances in full every month. Credit card companies encourage consumers to make low monthly payments so the companies can make money in the form of interest. Before you sign an application for a card, take a hard look.

A student is often given a credit limit of $1,000. The credit limit you're given does not necessarily reflect the balance you can afford to carry. For example, if you charge $1,000 at an 18 percent annual percentage rate (APR), it would take 12 years at the minimum payment to pay it off. You would pay $1,115 in interest alone during that period.

Use this credit card calculator to see how much it would cost to pay off your charges at the monthly amount you choose.

Shop around for a credit card that best fits your needs. You can get a free list of low-rate credit cards on the Bankrate website. When comparing the different offers, you'll need to understand the keys terms of the contract. Terms and conditions vary widely, so it’s important to compare all the terms of the offer. Key terms you should know include the following:

  • Annual percentage rate (APR): The amount of interest assessed on an outstanding credit card balance. For billing purposes, the APR is usually divided into periodic (monthly or daily) rates. A variable APR, often referred to as “prime + x%,” is tied to an economic market index such as the prime rate; thus it fluctuates with the economy. A fixed APR does not fluctuate with the market. Rather, it's set by the credit card company. Be aware that the company can change the rate on both variable and fixed cards with as little as 15 days notice to cardholders. APR can range from 7.99 to 30.25 percent.
  • Penalty APR: A much higher, punitive interest rate that credit card companies may apply to cardholders who have exceeded their credit limits, made one or more late payments, or are otherwise in bad standing. Penalty APRs are, on average, about 52 percent higher than regular APRs. Look for a card without penalty APRs.
  • Grace period: The time during which a transaction does not accrue interest. Grace periods range from zero to 30 days, with an average of 23 days. They often apply only to purchases, not cash advances or other transactions. Look for a grace period of at least 25 days.
  • Transaction fee: Cardholders are nearly always assessed additional fees for transactions other than purchases, such as cash advances. The fee is usually a percentage of the transaction, but a minimum fee may apply. Transaction fees may or may not be capped (i.e., have a maximum fee chargeable for a single transaction).
  • Cash advance: An immediate cash loan from a consumer’s credit card account. Cash advances may carry a higher APR than purchases and often are assessed transaction fees. Grace periods may not apply to cash advances.
  • Credit limit: The maximum balance that can be maintained on a card at any given time.
  • Minimum payment: The amount of money that must be paid on the account, usually on a monthly basis, to avoid late fees and maintain compliance with the credit contract.
  • Methods of computing balances:
    • Average daily balance: The outstanding balances for each day in the billing cycle are added and the total divided by the number of days in the billing cycle. New purchases may or may not be added, depending on the terms of the card. If the terms state that new purchases are included, purchases made during the billing cycle will raise a cardholder’s balance and may increase the finance charge. Once the average daily balance is calculated, interest is assessed each day at the daily rate, which is the annual percentage rate divided by 365.
    • Adjusted balance: Payments or credits received during the current billing are subtracted from the balance at the beginning of the billing cycle. New purchases are not included in the calculations. For example, if a cardholder’s beginning balance was $2,000 and they made a payment of $500 during the billing period, they would only be charged interest on the remaining $1,500. This is generally the most consumer-friendly computation method.
    • Two-cycle balance: Credit card companies add together the average daily balances for the current and previous billing cycles. The average daily balance for the current billing period may or may not include new purchases. The two-cycle balance method is the least consumer-friendly method of balance computation.
    • Secured credit card: This type of credit card is linked to a bank account, allowing a credit card company to deduct payment if the cardholder fails to pay.
  • Hidden transaction fees: Often buried in the fine print, these fees apply to cash advances and balance transfers. For example, if the card has a transaction fee of 3 percent and a minimum of $10, a cardholder who receives a $50 cash advance will be charged the minimum of $10, which amounts to an actual transaction fee of 20 percent.
  • Late fees: The fee assessed when you don’t pay on the due date. Look for a card with a low late fee.
  • High over-the-limit fees: These fees can range from $25 to $35. Many companies assess the fee when you exceed their limits by as little as $1.
  • Annual percentage increase: Penalty APR is triggered by a late or missed payment. It's usually several percentage points higher than the average regular APR.
  • Short grace periods: Grace periods have historically been 30 days. They now average several days less. Some cards have no grace period at all.
  • Low introductory rates: Generally, introductory rates turn into very high regular rates. The rate increases are not prominently disclosed. Read the fine print.
  • Bait-and-switch offers: The offer advertises a premium card, but the fine print allows the company to substitute another card - with a higher APR and fees - if the applicant doesn’t qualify for the premium card.
  • Know your financial limitations: Don’t spend beyond your means. Create a budget that takes into account your average credit card payments each month and stick to it.
  • Pay off your entire bill each month: Your best option is to buy only when you can pay your bill in full, before you decide to pay over time. Use this credit card payoff calculator to see how long it will take you to pay off your balance at the monthly payment you propose.
  • Reduce credit card fees: Getting rid of all but one or two cards means you avoid fixed costs, such as annual fees, and makes you less vulnerable to incurring multiple late payments and over-the-limit fees.
  • Be prepared to switch cards: If you're unable to pay off a large balance, pay as much as you can and switch to a credit card with a lower annual percentage rate (APR). You can view a list of low-rate credit cards on the Bankrate website.

Why Your Credit Rating Is Important

You're evaluated by your credit history every time you apply for credit, make a major purchase, lease an apartment, or apply for insurance or a job.

Your credit history includes information on your requests for credit or charge accounts, personal loans and insurance, as well as your history of payment on your bills, your income and the amount of your debts. It will show whether you have ever been sued, arrested or filed for bankruptcy.

This information is maintained and sold by a consumer reporting agency (CRA). The Fair Credit Reporting Act (FCRA) is a law intended to protect consumers by governing the way businesses and credit reporting agencies relay a consumer’s credit information.

You have the following protections under the FCRA:

  • You have the right to a copy of your credit report, which contains all the information in your file at the time. You can be charged a fee for this.
  • Your credit report should list all of the information gathered on you and the sources of the information. It also lists anyone who requested your credit report for employment purposes for the past two years and for most other purposes for the past year.
  • A consumer report may contain personal information, including your home and work addresses, as well as information on whether you have ever been arrested or filed for bankruptcy.
  • Consumer reports cannot be given to prospective employers without your consent.
  • If you disagree with the completeness or accuracy of information in your credit report, you can file a dispute with both the CRA and the company that supplied the information to the CRA. The CRA and supplier of information are obligated to investigate your dispute within 30 days.
  • If a dispute is not resolved to your satisfaction, you can add a summary explanation to your credit report.
  • If you're a victim of fraud, you're entitled to a free credit report.
  • A CRA cannot charge you when you dispute mistakes or outdated information on your credit record. Ask the credit bureau for a dispute form, and submit it with supporting documents.

If you are denied credit, insurance or employment because of information supplied by a CRA, you have the right to a free copy of your credit report, as long as you request it within 60 days of receiving the denial notice. The denial notice must advise you of your rights and provide the name, address and phone number of the CRA providing the report. The three national credit reporting agencies and their addresses are as follows:

P.O. Box 949
Allen, TX 75013

P.O. Box 740241
Atlanta, GA

P.O. Box 390
760 W. Sprowl Road
Springfield, PA

Include in your dispute copies of your receipts, sales slips and payoff letters. If you are unable to resolve the dispute to your satisfaction, federal law provides that you can add an explanation to your credit report regarding each item in dispute.

There is nothing a credit repair company can do for you that you cannot do yourself for little or no money. A CRA cannot charge you when you dispute mistakes or outdated information on your credit report.

The Federal Trade Commission (FTC) enforces credit laws and provides information on credit and other consumer issues. Call the FTC at 877-382-4357.